How are the average and marginal costs of production are related?

Average cost is the total cost per unit of output. It is c cost per unit. Average cost is the sum total of Average variable it and average fixed cost. Average cost depends on the behavior of AVC and AFC. AC curve falls first, reaches a minimum and therefore rises. In the beginning both AVC and AFC fall. In this stage the fall in AFC weighs more than the fall in AVC. AFC fully and AVC partly contribute to the fall of AC. After the minimum point is reached, AVC rises more stiffly and AFC continues to fall. The rise in AVC pulls up the AC curve upward. Thus Average cost appears to be the shape of English letter ‘U’.

Marginal cost, on the other hand, is the addition to the total cost by producing one more units of output. It is the difference between the previous total cost and the present total cost. It is the addition to the total cost of producing n units of output instead of (n-1) units. In symbols MC_n = TC_n – TC_{n- l} Marginal cost changes due to the change in variable costs-. It has therefore, no relation with the fixed cost which is given and constant. MC, can be expressed as ATC/AQ which represents’ the slope of the total cost curve.

In the table given above, the following points of relationship between average cost and marginal cost is shown.

(i) Both AC and MC are calculated from Total cost of production AC = TC/TO and MC = ATC/ATO.

Average cost shows the behaviour of TC over the wide range of output whereas MC is the slope of total cost curve.

(ii) When average cost is falling, marginal cost lies below the average cost. In the beginning when AC falls, MC falls faster. MC reaches a minimum and starts rising even then the AC is falling. MC lies below AC so long as AC is falling.

(iii) When AC is rising, MC lies above AC and rises faster- than AC. When AC rises MC also rises but at a faster rate. MC curve lies above AC curve.

(iv) The MC curve must cut the AC curve at its minimum point. At the minimum point of AC curve MC = AC. That means at this point MC cuts AC from below.

In the above diagram the M.C. curve intersects the. AC curve at the latter’s minimum point. The minimum point of the AC curve is P. At point P MC=AC. OM output is produced at the lowest average cost. When MC is above average cost, the average cost rises, i.e. MC pulls the AC upward.

On the other hand if MC is below the AC, average cost falls. This means MC pulls the AC downwards. When MC stands equal to the AC the average cost remains the same. When marginal cost is falling it lies below AC’ curve. But this does not mean that MC is falling. In the above diagram MC lies below AC but after the minimum point R, marginal cost rises although it is below AC. From point R to P MC lies below the AC, curve so that AC rises upward. It is thus it is clear, that when AC is falling, marginal cost may be falling or rising.