If marginal cost is less than average total cost, then is .
A) average total cost; falling
B) average variable cost; falling
C) marginal cost; falling
D) marginal cost; rising
The correct answer and explanation is :
The correct answer is:
A) average total cost; falling
Explanation:
To understand why, let’s break down the relationship between marginal cost (MC) and average total cost (ATC).
- Average Total Cost (ATC) is the total cost per unit of output produced. It includes both fixed and variable costs averaged over the number of units.
- Marginal Cost (MC) is the additional cost incurred by producing one more unit of output.
The key relationship between MC and ATC is similar to the relationship between a marginal value and an average value in mathematics:
- When MC is less than ATC, producing one more unit costs less than the current average. This pulls the average down.
- When MC is greater than ATC, producing one more unit costs more than the current average. This pushes the average up.
- When MC equals ATC, the average is at its minimum or maximum point (usually minimum in cost curves).
Why does this happen?
Think of the ATC curve as the average grade of a student in a class, and MC as the grade they get on the next test:
- If the next test grade (MC) is higher than the current average (ATC), the overall average rises.
- If the next test grade (MC) is lower than the current average (ATC), the overall average falls.
In the context of costs:
- If the cost of producing one more unit (MC) is less than the average cost so far (ATC), then producing that unit lowers the average cost.
- This causes the ATC to fall as output increases.
Additional Note:
This principle is crucial for firms when deciding how much to produce:
- If MC < ATC, increasing production decreases ATC, which is generally beneficial.
- However, once MC rises above ATC, producing more increases average costs, which might reduce profitability.
Thus, the behavior of ATC depends on the relationship between MC and itself, and the given statement, “If marginal cost is less than average total cost, then average total cost is falling”, perfectly aligns with this economic principle.