Question

Explain why the marginal cost curve intersects the average total cost curve at the level of output where average total cost is at a minimum.

Short answer

The marginal cost curve intersects the average total cost curve at the level of output where average total cost is at a minimum because MC influences the ATC. When MC is less than ATC, it brings the average down and when MC is more than ATC, it brings the average up. Thus, the ATC reaches its minimum when MC equals ATC.

Step-by-step solution

Identifying what is Average Total Cost (ATC) and Marginal Cost (MC)

ATC is the total cost of production divided by the number of goods produced while MC is the cost of producing one more unit. The ATC is usually U shaped because it initially decreases with an increase in output due to economies of scale and later increases due to diseconomies of scale. The MC also tends to follow a U shape; it decreases at first due to increasing marginal returns and then increases due to diminishing marginal returns.

Relationship between ATC and MC

MC is an additional cost incurred in producing one more unit. If MC is less than ATC, it brings the average down. Conversely, when MC is more than ATC, it pulls the average up. This means that the ATC decreases when MC is less than ATC and starts increasing when MC is more than ATC.

MC intersects ATC at its minimum point

MC intersects ATC at the minimum point of the ATC curve because ATC decreases when MC is less than ATC and starts increasing when MC is more than ATC. This implies that the MC curve will intersect the ATC curve at its minimum point as at this point onwards the MC becomes higher than ATC and the ATC starts increasing after reaching a minimum value.

Key concepts

Marginal Cost

Marginal Cost (MC) is an essential concept in economics, especially when analyzing the cost structure in production. It refers to the cost of producing one more unit of a good. Understanding MC helps businesses decide how much to produce in order to maximize profit.

• When the MC is lower than the price of the product, increasing production can increase profit.
• MC is typically represented as a U-shaped curve. Initially, as production increases, MC decreases due to increasing marginal returns. Eventually, it starts to rise because of diminishing marginal returns.

In practical terms, knowing the MC helps in decision making, particularly in determining the optimal level of production. For example, a company needs to gauge the cost implications of producing extra units before expanding production to ensure they are not incurring unnecessary expenses.

Average Total Cost

Average Total Cost (ATC) is another important concept that helps businesses understand their overall cost structure. ATC is calculated by dividing the total cost of production by the number of units produced. This gives an idea of the cost per unit.

• Similar to the MC, the ATC generally follows a U-shaped curve.
• The ATC decreases with an increase in output initially due to economies of scale. However, it increases after a certain point due to diseconomies of scale.

The interaction between MC and ATC is crucial:

• If the MC is less than the ATC, it means each additional unit is cheaper than the average, lowering the ATC.
• Conversely, if the MC is more than the ATC, it increases the average.

The point where the MC intersects ATC marks the minimum point of the ATC curve, indicating the most cost-efficient level of production.

Economies of Scale

Economies of scale refer to the cost advantages that businesses experience when production becomes efficient. As the scale of production increases, the cost per unit of output generally decreases. This happens because fixed costs are spread over a larger number of goods, and operational efficiencies improve.

• Examples of fixed costs include rent, salaries, and equipment.
• Improving operational efficiency can involve streamlined processes and technology adoption.

However, economies of scale are limited and eventually lead to diseconomies of scale when a company grows beyond its optimal size. At this point, costs start to increase per unit due to factors such as increased complexity, management inefficiencies, or higher costs of coordination.

• Understanding where these efficiencies end is important for businesses to avoid unnecessary cost spikes.

Overall, the concept of economies of scale helps explain why the ATC curve is U-shaped: it initially decreases due to economies of scale and then increases when diseconomies of scale set in.