Question

Explain the concept of marginal cost. How does the marginal cost of a good relate to its industry supply curve (under perfect competition)?

Answer 1

Marginal Cost(MC) is defined as the additional cost incurred in order to produce one additional(Marginal) unit of output

Mathematically MC = d(TC)/dQ where TC = Total Cost

For a perfect competitive firm Price is constant because perfect competitive firm is a price taker firm and Let that price be P

Profit = Total Revenue - TC

where Total revenue = Price*Quantity = PQ

=> Profit = PQ - TC

First order condition:

d(Profit)/dQ = 0 => P - MC = 0

=> P = MC

Note that MC is a function of Q

=> P = MC is also a function of Q

This P = MC shows the quantity a perfect competitive firm is willing to supply at different Price level.

Hence This Marginal Cost function(MC) represents supply curve of that firm.

Industry supply curve is the horizontal summation of individual supply curve and Hence Individual supply curve will be horizontal summation of Individual Marginal Cost Curve(Note Marginal Cost curve is also a supply curve for perfect competitive firm).