Question

1. Diagram the “cost template” for the firm and explain precisely how and why the marginal cost curve relates to the average cost curves at any output level.

Please show me your thought process. Please explain it as if you are telling it to someone who has no clue about economics.

Answer 1

Answer: For any firm the terms Output, Marginal Cost and Average cost are very important and they are interdependent also.

Whenever we intend to produce something, either goods or services, there is always a cost involved in getting a meaningful product which has a value in the market and can generate some revenue to coverup the cost of production.

Total Cost: Total cost is the sum of fixed and variable costs in producing Q units of output.

Marginal Cost: The marginal cost is the cost of producing one extra unit of a good. For example, from Q units to Q+1 units.

Average cost: It is the cost that is equal to total cost divided by the number of goods produced.

Since marginal cost and average cost, both are changing with every unit of output produced that is why the marginal cost curve relates to the average cost curves at any output level.

The below diagram shows the costs curves and their movement with each unit produced:

The cost curves diagram explains:

• With the increase in the average cost, the marginal cost becomes higher than the average cost.
• When the average cost decreases, the marginal cost becomes less than the average cost.
• When the average cost stays the same (is at a minimum or maximum), the marginal cost becomes equal to the average cost.