Question

What is the difference between average cost and marginal cost?

Hint:

A useful analogy: Think of your overall Grade Point Average (GPA) as the Average Cost. The grade you get in your next, single exam is the Marginal Cost. That single exam grade (MC) will pull your overall GPA (AC) up or down.

Answer 1

Average Cost (AC) and Marginal Cost (MC) are two fundamental concepts in economics and cost accounting that describe the cost structure of a firm.
Average Cost (AC):
Average Cost, also known as Average Total Cost (ATC) or unit cost, is the total cost of production divided by the total number of units produced. It represents the cost per unit of output. \[ \text{Average Cost (AC)} = \frac{\text{Total Cost (TC)}}{\text{Quantity Produced (Q)}} \] Marginal Cost (MC):
Marginal Cost is the additional cost incurred to produce one more unit of a good or service. It is the change in total cost that arises when the quantity produced is incremented by one unit. \[ \text{Marginal Cost (MC)} = \frac{\text{Change in Total Cost } (\Delta TC)}{\text{Change in Quantity } (\Delta Q)} \] Or, MC is the cost of producing the nth unit, which can be calculated as \(TC_n - TC_{n-1}\).
Key Differences: \begin{center} \begin{tabular}{| p{3cm} | p{6cm} | p{6cm} |} \hline Basis of Difference & Average Cost (AC) & Marginal Cost (MC)
\hline Meaning & It is the cost per unit of output. & It is the additional cost of producing one extra unit of output.
\hline Calculation & Calculated by dividing the total cost by the number of units produced (TC/Q). & Calculated by finding the change in total cost resulting from producing one more unit (\(\Delta TC / \Delta Q\)).
\hline Dependence & AC is calculated based on all units produced, including both fixed and variable costs. & MC is only affected by variable costs, as fixed costs do not change when one more unit is produced.
\hline Behavior & The AC curve is typically U-shaped. It initially falls due to economies of scale and then rises due to diseconomies of scale. & The MC curve is also U-shaped and it cuts the AC curve at its lowest point. MC falls faster and rises faster than AC.
\hline \end{tabular} \end{center}