Relationship between Marginal Cost (MC) and Average Cost (AC) - Free BCom Notes
Purpose: To illustrate the relationship between total, average and marginal costs. To show The bottom graph shows the average and marginal cost curves that. Relationship between Marginal Cost and Average Cost (With Diagram) It should be noted that average and marginal costs are related together. The marginal cost curve bears relationship to the average cost curve. It is very important to have a clear idea about this relationship as it plays an important role .
The marginal private cost shows the cost associated to the firm in question. It is the marginal private cost that is used by business decision makers in their profit maximization goals.
- Marginal cost
- Relationship between Marginal Cost (MC) and Average Cost (AC)
- Relationship between Marginal Cost and Average Cost (With Diagram)
Marginal social cost is similar to private cost in that it includes the cost of private enterprise but also any other cost or offsetting benefit to society to parties having no direct association with purchase or sale of the product.
It incorporates all negative and positive externalitiesof both production and consumption.
Examples might include a social cost from air pollution affecting third parties or a social benefit from flu shots protecting others from infection. Externalities are costs or benefits that are not borne by the parties to the economic transaction. A producer may, for example, pollute the environment, and others may bear those costs.
A consumer may consume a good which produces benefits for society, such as education; because the individual does not receive all of the benefits, he may consume less than efficiency would suggest. Alternatively, an individual may be a smoker or alcoholic and impose costs on others.
In these cases, production or consumption of the good in question may differ from the optimum level.
Negative externalities of production[ edit ] Negative Externalities of Production Much of the time, private and social costs do not diverge from one another, but at times social costs may be either greater or less than private costs.
When marginal social costs of production are greater than that of the private cost function, we see the occurrence of a negative externality of production. Productive processes that result in pollution are a textbook example of production that creates negative externalities. Such externalities are a result of firms externalizing their costs onto a third party in order to reduce their own total cost.
As a result of externalizing such costs, we see that members of society will be negatively affected by such behavior of the firm. In this case, we see that an increased cost of production in society creates a social cost curve that depicts a greater cost than the private cost curve.
In an equilibrium state, we see that markets creating negative externalities of production will overproduce that good. As a result, the socially optimal production level would be lower than that observed. Positive externalities of production[ edit ] Positive Externalities of Production When marginal social costs of production are less than that of the private cost function, we see the occurrence of a positive externality of production.
What is the Relationship between Average Cost and Marginal Cost? – Explained!
Production of public goods are a textbook example of production that create positive externalities. An example of such a public good, which creates a divergence in social and private costs, includes the production of education. It is often seen that education is a positive for any whole society, as well as a positive for those directly involved in the market.
Examining the relevant diagram we see that such production creates a social cost curve that is less than that of the private curve. In an equilibrium state, we see that markets creating positive externalities of production will underproduce that good. When MC rises above AC, it pulls the latter upwards.
What is the Relationship between Average Cost and Marginal Cost? - Explained!
Here, the ray from the origin is also tangent to the corresponding point of total variable cost curve. It shows that so long as the marginal cost curve lies below the average cost curve, the average cost falls pulled downwards by the marginal cost. On the other hand, when marginal cost lies above the average cost curve, the average cost rises pulled upwards by the marginal cost.
When marginal cost is equal to average cost, it is the minimum point of the latter. It is important to note that as long as the marginal cost is less than average cost, each additional unit of output will add less to total cost in comparison to the average per unit cost incurred on the previous units.
This lowers the overall average cost of production.
Marginal cost - Wikipedia
Hence, the average cost will continue to decline as long as the marginal cost is less-than the average cost whether the marginal cost is itself rising or falling. Further, when the marginal cost exceeds the average cost, each extra unit of output produced adds more to the total cost than the average cost incurred on the previous units, resulting in rise in the overall average cost of production.
This leads to a rise in the average cost curve, when the marginal cost is more than the average cost.