Question

Which of the following are true? (1) Average fixed costs never increase with output; (2) average total costs are always greater than or equal to average variable costs; (3) average cost can never rise while marginal costs are declining.

Short answer

Statements 1 and 2 are true; statement 3 is false.

Step-by-step solution

Understanding Average Fixed Costs

Average fixed costs (AFC) are calculated by dividing total fixed costs by the quantity of output produced. Since fixed costs are constant, as output increases, AFC always decreases because we are dividing a constant value by an increasingly larger number. Therefore, average fixed costs never increase with output.

Analyzing Average Total Costs and Average Variable Costs

Average total costs (ATC) consist of average fixed costs (AFC) plus average variable costs (AVC). Since AFC is always positive, ATC must be greater than or equal to AVC. Therefore, average total costs are always greater than or equal to average variable costs.

Evaluating Average Cost and Marginal Cost Relationship

Average cost (AC) can be affected by changes in marginal cost (MC). If MC is below AC, it pulls the AC down and the AC curve is decreasing. If MC is above AC, AC increases. If MC is decreasing, it could be either below or above AC. Therefore, average cost can rise even if marginal costs are declining, depending on their initial values in relation.

Key concepts

Average Fixed Costs

Average Fixed Costs (AFC) are a crucial concept in understanding cost behavior in microeconomics. They represent the fixed costs per unit of output. Since fixed costs do not change with the level of production, when we increase the output, the average fixed cost per unit decreases. This is because we are spreading the same total fixed costs over a larger number of units.

Imagine fixed costs as the same rent for a workspace regardless of how much you produce.

• If you produce 10 units, each unit bears a larger portion of the rent.
• If you increase production to 100 units, each unit now bears a smaller portion of the rent.

Therefore, as a principle, - **AFC always decreases** with an increase in output. - **It never rises**, because the fixed costs are constant and are spread over more units.

Average Total Costs and Average Variable Costs

Average Total Costs (ATC) encompass all costs per unit of output, derived from adding together the Average Fixed Costs (AFC) and Average Variable Costs (AVC). This relationship helps us understand how costs behave in various production levels.

Remember:

• AFC are part of ATC, always adding a positive value to AVC.
• This means ATC is always greater than or equal to AVC.

Visualize it like a layered cake, where the AVC forms the base layer and AFC adds on top to complete the cake. - The weight of AVC dictates the overall heaviness of ATC. - Since AFC is non-negative, ATC cannot be less than AVC, which ensures that ATC never falls below AVC.

Relationship Between Average and Marginal Costs

The relationship between Average Cost (AC) and Marginal Cost (MC) provides insights into how costs evolve as production scales up. Marginal Cost represents the cost of producing one additional unit.

Consider this relationship:

• If MC is less than AC, producing more can lower the average cost.
• If MC is more than AC, producing more can raise the average cost.
• If MC equals AC, the costs are stable without further changes.

However, it's possible for AC to rise even if MC is declining. This occurs when MC starts lower than AC and then inclines but remains below AC. The initial comparison of where MC lies in relation to AC ultimately influences the trend. Thus, declining MC doesn't necessarily ensure declining AC due to relative positions.