Explain the relationship between average cost and
marginal cost.
Answers
The various points of relationship between average cost and marginal cost are given below:
Both average cost and marginal cost are derived from total cost. Average cost is obtained by dividing total cost by the number of units produced. Marginal cost is the cost of producing one additional unit of output.
The total cost, in this reference, is the sum total of the total fixed cost plus total variable cost at a given level of output.
The marginal cost curve bears relationship to the average cost curve. It is very important to have a clear idea about this relationship as it plays an important role in the price theory.
The various points of relationship between average cost and marginal cost can be summed up as follows:
(i) When average cost falls with increase in output, marginal cost becomes less than average cost.
Average cost goes on falling up to a certain level of output, marginal cost is less than average cost and beyond that point, marginal cost becomes more than average cost.
In QQ is the level of normal capacity, till that point AC curve falls downward, MC curve lies below AC curve.
(ii) MC begins to rise at a lesser level of output than AC. Marginal cost curve begins to rise from OQ, level of output.
(ii) At the level of optimum output, average cost is minimum and constant. At this point marginal cost becomes equal to the average cost, the marginal cost curve cuts the average cost curve at point R.
This point may be known as optimum Point where average cost (AC) and (MC) will be equal and minimum.
(iii) With increase in average cost, marginal cost rise at a faster rates. Beyond OQ level of output MC curve is above AC curve.
A close study of the above table reveals the following points:
1. Where marginal cost is falling total cost will be rising at a declining rate; on the other hand, where marginal cost is rising, total cost will be rising at an increasing rate.
2. When marginal cost is lower than the average cost average cost would be falling. In other words, when marginal cost is greater than the average cost, the average cost would be rising.
3. If the marginal cost first falls and then rises the marginal cost curve is U-shaped, the marginal cost will be equal to the average cost at a point where the average cost is the minimum.
4. If the marginal cost is below the average variable cost, the latter must be falling and vice-versa.
5. If the marginal cost first falls and then rises, it will be equal to the average variable cost at a point where the average variable cost is minimum.