Ans. Average cost is the total cost divided by the total quantity produced. Marginal cost is the extra cost of producing one additional unit.
The relationship among total cost, average cost, and marginal cost is shown in Table 3.1.
A study of the above table reveals the following points:
1. Average cost is equal to total cost divided by the number of units produced. For example, at an output of 13 units, the total cost is Rs.624. Here the average cost is Rs.48.
2. The total cost is equal to the sum of fixed cost and all the marginal costs uncured. For example, at an output of 5 units, the total cost is initial cost to which the firm is committed irrespective of the quantity produced.
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3. Where marginal cost falls, total cost will be rise at a declining rate; on the other hand, where marginal cost is rises, total cost will rise at an increasing rate.
4. When marginal cost is lower than the average cost, average cost will fall; for example, up to 12 units of output as shown in Table 3.1. This will be so irrespective of the fact whether the marginal cost is rising or falling. For example, for an output of 11 and 12 units, the marginal cost rises, but the average cost falls.
5. Where the marginal cost is greater than the average cost, the average cost will rise; for example, for outputs at 14 and 15 units.
6. If the marginal cost first falls and then rises, i.e., the marginal cost curve is U-shaped, the marginal cost will be equal to the average cost at a point where the average cost is the minimum. For example, at an output of 13 units, the average cost is the lowest at Rs.48 where the marginal cost is also Rs.48.
7. If the marginal cost is below the average variable cost, the latter will fall. This is exemplified in Table 3.1 up to 11 units of output.
8. If the marginal cost is higher than the average variable cost, the latter must be rising. This is exemplified in Table 3.1 at output levels of 13, 14, and 15 units.
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9. If the marginal cost first falls and then rises, it will be equal to the average variable cost at a point where the average variable cost is the minimum. This is so at an output level of 12 units where the marginal cost and the average variable cost are equal to Rs.33.