Question

Explain the relationship between total cost, average cost and marginal cost with the help of diagrams.

Answer 1

Relationship between TC, AC and MC:

Total Cost (TC) Curve:

1. TC = TFC + TVC (Total Cost = Total Fixed Cost + Total Variable Cost)
2. The TC curve starts from a positive point on the Y-axis (because fixed cost exists even when output is zero).
3. TC rises slowly at first (due to increasing returns), then sharply (due to diminishing returns).

Average Cost (AC) and Marginal Cost (MC) Curves:

1. Average Cost (AC):
   1. AC = TC ÷ Output
   2. AC is U-shaped:
      • Falls initially due to better use of resources
      • Rises later due to inefficiency
2. Marginal Cost (MC):
   1. `MC = (DeltaTC)/(Delta "Output")`
   2. MC is also U-shaped and intersects AC at its minimum point.

1. Total Cost (TC) Curve: Starts above the origin and slopes upward. It shows total cost increases as output increases. Shape is S-shaped due to increasing and then diminishing returns.
2. Average Cost (AC) Curve: U-shaped. It falls at first as fixed costs spread over more units, then rises due to rising variable costs.
3. Marginal Cost (MC) Curve: Also U-shaped. It cuts the AC curve at its lowest point.
   1. When MC < AC, AC falls.
   2. When MC > AC, AC rises.
   3. When MC = AC, AC is minimum.