Economics Cost Of Production Questions Long
The relationship between average cost and marginal cost is an important concept in economics that helps to understand the cost structure of a firm.
Average cost (AC) is the total cost of production divided by the quantity of output produced. It represents the average cost per unit of output. On the other hand, marginal cost (MC) is the additional cost incurred by producing one more unit of output. It represents the change in total cost resulting from a change in output.
The relationship between average cost and marginal cost can be summarized as follows:
1. When marginal cost is below average cost: In this situation, the marginal cost of producing an additional unit of output is lower than the average cost. This implies that adding one more unit of output reduces the average cost. As a result, the average cost curve decreases. This occurs when the firm experiences economies of scale, benefiting from increased efficiency and spreading fixed costs over a larger output.
2. When marginal cost is equal to average cost: When marginal cost equals average cost, the average cost curve is at its minimum point. This occurs when the firm is operating at its optimal level of production, where the cost per unit of output is minimized. At this point, the firm is neither experiencing economies of scale nor diseconomies of scale.
3. When marginal cost is above average cost: In this case, the marginal cost of producing an additional unit of output is higher than the average cost. This implies that adding one more unit of output increases the average cost. As a result, the average cost curve increases. This occurs when the firm experiences diseconomies of scale, where the cost per unit of output increases due to inefficiencies or increased coordination problems as the firm expands its production.
In summary, the relationship between average cost and marginal cost is such that when marginal cost is below average cost, the average cost decreases. When marginal cost equals average cost, the average cost is at its minimum. And when marginal cost is above average cost, the average cost increases. Understanding this relationship is crucial for firms to make informed decisions regarding their production levels and pricing strategies.