Question

Evaluate each of the following statements. If a statement is true, explain why; if it is false, identify the mistake and try to correct it. a. A decreasing marginal product tells us that marginal cost must be rising. b. An increase in fixed cost increases the minimumcost output. c. An increase in fixed cost increases marginal cost. d. When marginal cost is above average total cost, average total cost must be falling.

Short answer

Answer: When the marginal product decreases, the marginal cost rises. This happens because a decreasing marginal product means that an additional unit of input is producing less and less output. To produce the same level of output, the firm will need to use more inputs, which in turn increases the cost of production. As a result, the marginal cost (the cost to produce one more unit of output) will rise.

Step-by-step solution

Statement a

A decreasing marginal product tells us that marginal cost must be rising. This statement is true. When marginal product decreases, it means that an additional unit of input is producing less and less output. To produce the same level of output, the firm will need to use more inputs, which increases the cost of production. As a result, the marginal cost (the cost to produce one more unit of output) will rise.

Statement b

An increase in fixed cost increases the minimum cost output. This statement is false. An increase in fixed cost will increase total cost, but it does not affect the minimum cost output. The minimum cost output is reached when the average total cost is minimized, and it can be found when the marginal cost equals the average total cost. Since fixed costs do not affect marginal cost, an increase in fixed cost will not affect the minimum cost output. A corrected statement would be: An increase in fixed cost increases the total cost but does not affect the minimum cost output.

Statement c

An increase in fixed cost increases the marginal cost. This statement is false. Fixed costs are costs that do not change with the level of output, such as rent or insurance. An increase in fixed cost will increase the total cost, but it will not directly affect the marginal cost. The marginal cost refers to the cost of producing one additional unit of output and is affected by variable costs such as wages and raw materials. A corrected statement would be: An increase in fixed cost increases the total cost but does not directly affect the marginal cost.

Statement d

When marginal cost is above average total cost, average total cost must be falling. This statement is false. When marginal cost is above average total cost, the average total cost is actually increasing. To see why, consider that marginal cost represents the cost of the additional unit while the average total cost represents the average cost per unit of output. If the cost of the additional unit (marginal cost) is greater than the previous average cost, then the new average will be higher than the old one, meaning the average total cost is increasing. A corrected statement would be: When marginal cost is above average total cost, average total cost must be increasing.

Key concepts

Decreasing Marginal Product

The concept of decreasing marginal product indicates a situation where adding more of a variable input, such as labor, results in a smaller increase in output. Imagine you’re in a kitchen trying to cook dinner with friends. Initially, having more friends helping might speed things up, but if too many join, they'll start bumping into each other. The kitchen becomes overcrowded, leading to inefficiencies. Similarly, in production, as each additional input contributes less to the overall output, costs to produce each additional unit rise.
This directly relates to rising marginal costs. As the marginal product lowers, firms need more and more inputs to produce the same output level. Since they need to invest more resources just to maintain their production rate, the cost of producing one more unit, known as the marginal cost, increases. Thus, decreasing marginal product goes hand in hand with rising marginal costs.
Understanding this relationship is essential, as it guides businesses in deciding the optimal level of input to maintain cost-effectiveness. By carefully monitoring the production process, businesses can find the balance where inputs maximize output without causing costs to spiral upwards.

Fixed Costs

Fixed costs are expenses that do not change regardless of the production volume. Think of them as the cost of setting up the show, happening whether or not the show goes on. Examples include rent, salaries of permanent staff, and insurance premiums.
Even if a company decides to halt production briefly, they still need to cover fixed costs. Therefore, no matter how much the firm produces, these expenses stay constant.
However, fixed costs don't influence the marginal cost directly. When fixed costs rise, the overall total cost increases, but this doesn't affect the marginal cost, which accounts for variable expenses. Fixed costs contribute to the total cost calculation, especially important when determining the firm's break-even point, the period when revenues match total costs.

Average Total Cost

The average total cost (ATC) is the total cost per unit of output produced. It includes both fixed and variable costs, spread out across the whole unit of production.

• ATC = Total Cost / Quantity of Output

Average total cost helps visualize how efficiently a company is producing goods or services. When marginal costs begin to rise beyond average total costs, it means each additional unit costs more than the average of the previous units. Thus, average total costs will increase.
To illustrate, imagine you’re filling a bucket with water. If the last cup added spills out more water than what the bucket is holding on average, the level in the bucket rises. Similarly, when the marginal cost (cost of producing one more unit) is above the ATC, the ATC increases. Keeping track of the ATC is crucial for businesses, as it influences pricing strategies, potential profitability, and understanding competitive market position. Effective cost management ensures a balance between growing production efficiently and controlling expenses.