RELATION BETWEEN AVERAGE COST AND MARGINAL COST IN SHORT RUN – Learn Economics
Both marginal cost (MC) and average cost (AC) are derived from the total cost. They bear unique relationship. The relationship between MC and AC can be. Marginal Cost (MC) & Average Total Cost (ATC). Total cost is variable cost and fixed cost combined. TC=VC+FC. Now divide total cost by quantity of output to get . For example, average cost (AC), also called average total cost, is the total cost Relationship Between Marginal and Average Variable Costs.
What I want to do in this video is think about a fairly traditional business. I am going into the orange juice business.
What is the Relationship between Average Cost and Marginal Cost? – Explained!
Right over here, I've written the gallons of orange juice I am going to produce each week, so all of this is going to be in a per week basis. I'm assuming all of those are fixed cost, and I can't get out of them or buy them overnight, that I've decided, I've plunked down the cost for the machine, and I've given these employees, let's say I've given them already a one-year contract.
These are going to be fixed, at least for the next year.
Now, my variable costs, here, these are going to be given the amount of juice I want to produce. This is going to be the cost of the oranges, and I guess we can also say the cost of transporting the oranges, and so we see here, obviously if we produce no oranges, we have no variable cost.
What is the Relationship between Average Cost and Marginal Cost?
If we produce 2, it'sand something interesting happened. The first 1, oranges wasand then the next 1, it was only So what's happening here is I've probably got some economies I've probably got some negotiating power now with some of these suppliers.
I'm like, "Look, I'm buying a lot more oranges now. The incremental from this to this is only Then it starts getting more expensive again. What's probably happening is, as I start buying more and more oranges from the local distributors, I get a better, better deal. They view me as a bigger and bigger customer, but once I tap them out, then I have to go further and further away. Maybe it's costing more to transport them, or maybe these other suppliers don't take me as seriously or I go to slightly more expensive suppliers because I've tapped out all of the cheap ones, and so my incremental variable costs for the next 1, and we'll think about that later, keeps going up and up and up.
The total costs, obviously, are just the sum of my fixed costs and my variable costs. Let's calculate using, and I'm just using Excel, here. Let's calculate the average fixed cost, so we don't want to divide by zero.
Marginal cost and average total cost
Remember, the average cost, the average fixed and the average variable and the average total cost, these are each of those costs divided by the total amount of juice that I'm producing. You can kind of view them as the cost per gallon.Marginal Cost class Xll Economics
So that we're thinking of the average fixed cost per gallon, so what we're going to do, so I'm writing equal to let Excel know that I'm doing a formula now, this is going to be equal to my fixed cost divided by, so divided by, divided by my gallons, and you can see that's G8 divided by F8, and actually, I guess you can't see my Gs and Fs, but this is the 8th row. If I want my average variable costs, that's going to be my variable costs divided by, divided by my total number of gallons, so that's 50 cents, so that's the first 1, gallons to produce the orange juice, the orange juice for That includes the transportation cost.
Then the total is just the sum of these two things. Or, we could have done it another way.
Marginal cost and average total cost (video) | Khan Academy
We could have taken this right We could have said that this is just equal to, this is just equal to our total cost, our total cost divided by the total number of gallons. It shows that so long as the marginal cost curve lies below the average cost curve, the average cost falls pulled downwards by the marginal cost.
On the other hand, when marginal cost lies above the average cost curve, the average cost rises pulled upwards by the marginal cost. When marginal cost is equal to average cost, it is the minimum point of the latter. It is important to note that as long as the marginal cost is less than average cost, each additional unit of output will add less to total cost in comparison to the average per unit cost incurred on the previous units.
This lowers the overall average cost of production. Hence, the average cost will continue to decline as long as the marginal cost is less-than the average cost whether the marginal cost is itself rising or falling. Further, when the marginal cost exceeds the average cost, each extra unit of output produced adds more to the total cost than the average cost incurred on the previous units, resulting in rise in the overall average cost of production.
This leads to a rise in the average cost curve, when the marginal cost is more than the average cost. Finally, if the additional unit of output produced costs same as the average cost incurred on the previous units, the overall average cost does not change and attains its minimum value.
Thus, when the average cost reaches its minimum level, it is equal to the marginal cost.