Question

Explain the concept of Total Cost, Average Cost and Marginal Cost.

Answer 1

Total costs: Total cost describes the total economic cost of production. It is composed of variable and fixed,and opportunity costs.

Average costs: Average costs is equal to total cost divided by the number of goods produced ( the output quantity ).

Marginal cost: Marginal cost is the change in total costs that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of good. Mathematically the marginal cost ( mc ) function is expressed as the first derivative of the total cost ( TC ) function with respect to quantity.

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Answer 2

TOTAL COST

All the costs of producing a good or service are called total costs. In the SHORT RUN, total costs can be divided into two parts: FIXED COSTS, i.e, those costs which do not vary with output, and VARIABLE COSTS, i.e. those costs which vary directly with output.

In the short run, the output can only be changed by adjustment of the variable factor inputs. The long-run total cost schedule of a profit-maximizing firm is then given by those factor input combinations which minimize total cost at all output levels.

AVERAGE COST

Average cost is 'change in total cost divided by change in output'. Thus, the average (total) cost (ATC) may be written as

ATC= TC/X,

where X is output and TC is TOTAL COST.

Marginal Cost

The cost of producing another unit of output. Algebraically it is written

MC = ΔC/ΔX,

where Δ means 'a small change in', C = total cost and X = output.

In the SHORT RUN, the marginal cost curve slopes upwards due to the operation of the law of diminishing returns.  Note also that marginal cost cannot be affected by the level of FIXED COSTS.  Quite simply, if an extra unit of output is produced fixed costs do not change and hence extra fixed costs must be zero.  It follows that marginal cost is determined by VARIABLE COSTS only.  In the LONG RUN, marginal costs may rise, fall or stay constant depending on the presence of economies or diseconomies of scale.