Question

Think about how demand and supply may change over time given certain events. What is the relationship between average total cost and marginal costs?

Answer 1

Demand and supply changes over time given certain events due to change of the determinants of demand and supply.

Determinants of demand are

1. Price of the product
2. Income of the consumer
3. Price of the related goods
4. Taste and preference of the consumer
5. Advertisement expenditure
6. Population growth
7. Government policy

Determinants of supply are

1. Price of the product
2. Price of the related goods
3. Technique of production
4. Cost of the factor of production
5. Future expectation of change in price

Any change of these determinants would result in change in the demand and supply of a product, which affects the revenue and cost decision of the firm.

Relationship between the ATC (Average Total Cost) and MC (Marginal Cost)

(A) Both ATC and MC calculated from total cost (TC)

ATC is the total cost per unit of output, it can be obtained by dividing the total cost with the unit of output produced, so                ATC = TC / output (Q)

MC is the addition to the total cost (TC) due to producing an additional unit of output. It can be obtained,             MC = ΔTC / ΔQ    

(B) When MC falls, ATC also falls but the falling of MC is more than the falling of ATC. In other words when MC < ATC, ATC should be falling. In the diagram at Q1 unit of output MC (BQ1) is less than ATC (AQ1).

(C) When MC rises, ATC also rises. But the rising of MC is more than the rising of ATC, in other words MC > ATC, ATC should be rising. In the diagram at Q3 unit of output MC (DQ3) is more than ATC (CQ3).

(D) MC cuts ATC at its lowest or minimum point, in other words if MC = ATC, the slope of the ATC should be constant. So when slope of ATC is constant MC becomes equal to ATC. Which is shown at point E, MC = ATC =EQ2 at output Q2

MC ATC 01 Q2 Q3 Output