Costs - The key relationship

Average Cost and Marginal Cost

These are two of the most commonly misunderstood terms by economics pupils. I believe the key to studying costs is understanding the relationship between average costs and marginal costs.


The average cost is calculated by dividing the Total Cost by the Quantity.
The marginal cost is the difference in the total cost for the addition of an extra unit.



We know that while MC < AC, the average cost is falling and when MC > AC, the average cost is rising. But whats important is understanding why...

Think of a footballer who scores two goals per game. His average is 2 and if he continues scoring two goals in every game, his marginal number of goals is also 2. However if goes and scores 4 goals in his next game (his marginal goals (4) is above his average (2) goals per game), so his overall average will rise. Likewise if he has a bad game and doesn't score (his marginal goals (0) is below his average(2) so his overall average will fall.

When we look at the graph, we see that MC curve cuts the AC curve at the lowest point on the AC curve. This is where AC is at its lowest, we said above once MC is > than AC, the average cost rises. This is the same with the curve, Once the MC curve goes above the AC curve, The AC curve starts to rise.