Question

module 6 discussed the relationship between marginal cost and average cost. Specifically it stated that when marginal cost is above average cost, average cost rises. Describe why this is the case? What happens when marginal cost is below average cost?

Answer 1

Initially both marginal cost(MC) and average cost(AC) is falling. MC falls upto a point, say till output Q1 and then starts rising. AC continues to fall till a point say till output Q2. Therefore, till output level Q2, MC is less than AC. At output Q2 AC hits the minimum and MC=AC. Since MC curve is U-shaped as diminishing returns starts to operate after output Q1, and MC starts increasing at an increasing rate after Q1. Till Q2 MC was already increasing at an an increasing rate. After Q2, even AC starts increasing at an increasing rate, but always remain below MC after output Q2, as rate of increase in AC always remains lower than rate of increase in MC. So, MC equals and thus intersects AC at its minimum. Hence, after MC crosses AC from below, AC is risng persistently.

As already mentioned, when MC is below AC, it falls till an output say Q1, and starts rising after that as diminishing returns operate. Then MC starts rising at an increasing rate and reaches Q2, where it intersects the AC curve at its minimum.