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Explain the terms T.C., A.C. and M.C. with examples. Why does the long run
A.C. curve is saucer shaped?

Q-3) Explain the terms T.C., A.C. and M.C. with examples. Why does the long run
A.C. curve is saucer shaped?

Average costs [A.C.]are calculated using total costs [T.C.]of production, while marginal costs[M.C.]  considers the cost of one additional unit.

Marginal and Average Costs

Marginal and average costs are related but different.
Key Points

The price of goods are determined by their marginal value.  In a competitive economy, price will equal marginal cost.

Economics assumes that a rational decision-maker will produce or consume whenever the marginal benefits of the good outweigh the marginal costs.

A company has a fixed per person cost of A for a perishable good. If no one is willing to spend A before the good expires, should the company accept a lower price of B? The answer is yes, so long as the marginal costs of the good is covered, then the company will make some profit.

Terms  average cost

In economics, average cost or unit cost is equal to total cost divided by the number of goods produced.

marginal cost

The increase in cost that accompanies a unit increase in output; the partial derivative of the cost function with respect to output. Additional cost associated with producing one more unit of output.

marginal analysis

The process of making a decision by weighing the incremental effects on costs and benefits.


Marginal analysis can be used to explain why diamonds exchange for more than water, which people need in order to live. It also explains how companies decide whether or not to produce an additional good, how consumers decide whether or not to buy an additional product, or stores decide whether or not to stay open an additional hour.

When a firm makes a decision about whether or how much of a good to produce, it faces both marginal and average costs. The marginal cost (MC) of a good is the incremental cost of producing one more unit of that good--it is the change in total costs associated with producing one more unit--while the average cost (AC) of the good is found by taking the total cost of production and dividing it by the number of goods produced. These can be the same or different. For example, if a business produces friendship bracelets, and the cost of producing a bracelet is simply the cost of the yarn and the labor, the marginal cost will equal the average cost. On the other hand, consider a company that produces cars. The company must first pay for the factory and machinery, which costs $500,000, and only then can it start manufacturing vehicles. The cost of the materials and labor to produce one additional car is $10,000--this is the marginal cost--but the average cost must also take into account the cost of the factory. If only one car is produced, its average cost is $510,000, but if 100 cars are produced, the average cost of each car is only $15,000 .

Economists argue that the decisions are made "at the margin"--that is, decision-makers will look at the marginal costs and benefits of an action, not the average costs and benefits. The process of making these decisions is called marginal analysis. The basic idea is that every choice, whether it is a decision by a consumer to buy a good or a decision by a business to produce one more good, is different from the previous one in regards to cost and benefits. A consumer of ice cream will derive less utility (benefit) from the second cone than from the first. He will benefit even less from the third cone and so on, a concept known as the law of diminishing marginal utility. Therefore, the value of successive cones (marginal benefit) decreases in the eyes of the consumer, while the price (marginal cost) remains constant. As a result, the decision to buy the first cone may make sense (as the benefits outweigh the costs), but buying the second cone may not (if the costs now outweigh the benefits).

What does it mean that the participants in a market (households and firms) make their decisions at the margin? It means that they consider each new decision individually, weighing the marginal costs (MC) and marginal benefits (MB) of the choice. For example, assume that a firm has already produced 9 units of a good. In this case, we would say that the marginal unit is the tenth unit of production. The firm will produce the tenth unit if its marginal benefit (market price) is greater than its marginal cost. The firm will not produce the tenth unit if the marginal costs outweigh the marginal benefits. It will make a separate decision using the same method in determining whether to produce the eleventh unit of the good. Assuming increasing marginal costs,this will continue until the marginal costs of producing an additional unit are greater than its marginal benefits, at which point the firm will halt production. Consumers behave in a similarly incremental fashion in regard to buying goods. This analysis yields the following "marginal decision rule." An individual or business should engage in any activity so long as the MB > MC. The optimal level of activity is where MB = MC. The average cost is irrelevant when making these decisions.  
Long-Run and Short-Run Costs
When output exceeds qM , the firm has rising unit costs. Such
an increasing-cost firm is said to encounter decreasing
returns to scale.
This results from either difficulties in managing and controlling
an enterprise as its size increases, or alienation of the labour
force as the size increases.
Note: Decreasing returns to scale (long run) are not the same
as diminishing marginal returns (short run).


Each SRATC curve is tangent to the LRAC curve at the level of
output for which the quantity of the fixed factor is optimal.
Shifts in LRAC Curves
Changes in technology and factor prices cause the long-run
cost curve to shift.
A rise in factor prices shifts the LRAC curve upward. A fall in
factor prices or a technological improvement shifts the LRAC
curve downward.
In the very long run, there are changes in the available
techniques and resources for firms. Such changes shifts
the long-run cost curves.
Technological change refers to all changes in the available
techniques of production.
Economists use the notion of productivity to measure the
extent of technological change.


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