Question

Display and explain the average variable cost curve.

Display and explain marginal revenue, marginal cost and profit maximization.

Answer 1

1) In economics, the average variable cost (AVC) is computed as total variable costs divided with the quantity of output produced. The AVC curve at any level of output would be below the curve for average total cost (ATC) because ATC includes average fixed cost and average variable cost. The shape of the average variable cost curve is U-shaped because an input in the short run is fixed, and the law of diminishing return along with a fixed input would determine the marginal product of factors; and as a result the AVC at small quantities of output will be high, and when production increases it declines and reaches to minimum level and then increases.

2) The marginal revenue refers to the additional total revenue that can be earned with the sales by one additional unit of output. The marginal cost refers to the cost of each extra unit of a given output. The profit maximization occurs when marginal revenue equals marginal cost because at this point marginal profit is zero. In the enclosed graph-2:

At A, MR > MC, thus for each extra unit produced, revenue exceeds the cost so that firm can generate more.

At B, MR< MC, then for each additional unit produced, the cost exceeds the revenue so that the firm will create less

Thus the optimal quantity produced would be the point where MR = MC