Cost Concepts 2: The Relationship between Total Cost, Average Cost and Marginal Cost

Reviewed by Omotolani Ajileye

The Relationship Between Total Cost (TC), Average Cost (AC) and Marginal Cost (MC)

Understanding the relationship between total cost, average cost and marginal cost is crucial for analyzing production expenses as output changes.

• Total Cost refers to the overall expense incurred in producing a given level of output. This cost typically increases as more goods are produced because additional resources are required.

• Average Cost is the cost per unit of output. It is calculated by dividing total cost by the number of units produced.

• Marginal Cost is the additional cost incurred when producing one more unit of output. This cost directly influences the total cost as production increases.

The Impact of Marginal Cost on Average Cost

• When marginal cost is lower than average cost, it pulls the average cost down, causing the average cost curve to fall.

• When marginal cost exceeds average cost, it pushes the average cost upwards, making the average cost curve rise.

• When marginal cost equals average cost, the average cost reaches its lowest point. This is where the marginal cost curve typically intersects the average cost curve, which helps firms determine the most efficient level of production and manage costs effectively.

Relationship Between VC, MC, AVC, ATC and AFC

The relationship between variable cost (VC), marginal cost (MC), average variable cost (AVC), average total cost (ATC) and average fixed cost (AFC) is integral to production analysis:

• Variable Cost increases as output rises because more resources such as raw materials and labour are needed.

• Marginal Cost is mainly influenced by changes in variable cost since fixed costs do not change with output. Initially, marginal cost decreases due to better resource use but…