Q4Managerial Economics & Financial Accounting
Question
Discuss the relations between Average Cost and Marginal Cost of a firm.
Answer
The MC curve physically pulls the AC curve. MC cuts AC at its lowest point. If MC < AC, AC falls; if MC > AC, AC rises.
The mathematical and graphical relationship between AC (Total Cost / Quantity) and MC (Cost of the additional unit) is fundamental in microeconomics. Both are U-shaped curves, but MC drives the behavior of AC.
The Three Key Relationships: 1. When : The cost of producing the next marginal unit is lower than the average of all previous units. Therefore, the new marginal unit pulls the average down. AC is falling. 2. When : The cost of the next unit is higher than the current average. The new unit pulls the overall average up. AC is rising. 3. When : This is the mathematical intersection. The marginal cost exactly matches the average. At this exact point, AC is at its absolute minimum. Geometrically, the MC curve always cuts the AC curve from below at AC's lowest point.