Question

Where does the marginal cost curve intersect the average variable cost curve and the average total cost curve?

Short answer

The marginal cost curve intersects both the average variable cost curve and the average total cost curve at their minimum points.

Step-by-step solution

Understanding the Concepts

Marginal cost (MC) is the cost of producing an additional unit. Average variable cost (AVC) is the total variable cost per unit of output. Average total cost (ATC) is total cost per unit of output. AVC and ATC curves are U-shaped due to the presence of fixed costs and the law of diminishing marginal returns.

Relationship between MC and AVC

The MC curve intersects the AVC at its lowest point. This is because when marginal cost is less than average variable cost, it pulls the average down. When the marginal cost is higher than the average variable cost, it pulls the average up. So, AVC reaches its minimum value when it is equal to MC.

Relationship between MC and ATC

The MC curve intersects the ATC at its minimum point for the same reasoning. It's because when the MC is below ATC, it pulls the average down and when MC is above ATC, it pushes it up. So, the ATC curve reaches its minimum value where it is equal to MC.

Key concepts

Marginal Cost

Marginal cost (MC) represents the additional cost incurred for producing one more unit of a good or service. It is derived from the change in total costs associated with a change in quantity. Imagine you're making pizzas; the cost of ingredients for each additional pizza is the marginal cost. Mathematically, if the total cost for one level of production is \( TC_1 \) and for the next level is \( TC_2 \) the marginal cost is \( MC = TC_2 - TC_1 \). Understanding MC is crucial in determining the optimal production level and plays a significant role in pricing and profitability.

When analyzing marginal cost, it is essential to consider the law of diminishing marginal returns, which implies that as you continue to produce more, the cost for each subsequent unit may increase due to factors such as limited resources or declining efficiency. This law shapes the MC curve, typically making it upward sloping after a certain point in production levels.

Average Variable Cost

Average variable cost (AVC) is what it costs a firm, on average, to produce one unit of a good or service, excluding fixed costs. Variable costs change with the level of output, like the cost of raw materials or labor that goes up and down depending on how much a company produces. To calculate AVC, total variable costs (TVC) are divided by the total output (Q), or \( AVC = TVC/Q \).

As production increases, initially, AVC typically decreases due to the spreading out of variable costs over a larger number of units. However, due to the law of diminishing marginal returns, the AVC will eventually start to rise as those variable costs per unit increase. This gives the AVC curve its characteristic U-shape.

Average Total Cost

Average total cost (ATC) includes all costs—both fixed and variable—associated with production, averaged over the total quantity produced. Fixed costs, such as rent, remain constant regardless of the amount produced, while variable costs change with production volume. To compute ATC, the sum of total fixed costs (TFC) and total variable costs (TVC) is divided by total output \( ATC = (TFC + TVC) / Q \).

The ATC curve, similar to AVC, is generally U-shaped because at low levels of output, spreading out high fixed costs over a few units makes ATC high. As output increases, these fixed costs are distributed across more units, lowering ATC. Eventually, rising variable costs lead to an increase in ATC due to the law of diminishing marginal returns.

Cost Curves Relationship

The relationship between MC, AVC, and ATC curves is fundamental to understanding cost behavior in economics. The MC curve intersects both the AVC and ATC curves at their lowest points. This intersection signifies a shift; where MC is lower than AVC or ATC, it pulls the averages down. Conversely, where MC is higher, it pushes them up.

The intersection points also indicate the minimum costs. For AVC, any additional unit cost (MC) that is lower than the current AVC will reduce the AVC, but once MC exceeds AVC, the AVC starts increasing. The same principle applies to ATC. This is why the MC curve is crucial for determining the most efficient production level—where it crosses the AVC and ATC curves is where the firm achieves the lowest average costs possible.

Law of Diminishing Marginal Returns

The law of diminishing marginal returns, a cornerstone in the study of economics, states that if additional units of one factor of production are added to a fixed amount of other factors, beyond a certain point, the marginal product of additional units will decline. This means after an optimum level of capacity is reached, every extra unit of production will not add as much output as the ones before it.

This law affects AVC and ATC as well, as initially, the addition of more resources (like labor) improves output per unit, decreasing average costs. However, as production continues to expand with those fixed resources, inefficiencies kick in, and additional units add less output, raising the cost per unit. This dynamic underpins the U-shape of the AVC and ATC curves and the typical initial downward slope following by the uptick of the MC curve.