Question

Explain the relationship between AC and MC. Can the AC curve fall when MC curve is rising? Explain it with the help of diagram.

Answer 1

Marginal cost is an addition made to total cost by producing an extra unit of output. It is expressed as :

$MC=\frac{\Delta TC}{\Delta Q}$ or $T{C}_n-T{C}_{n-1}$

Average cost is obtained by dividing the total cost by the units of output. It is expressed as:

AC $=\frac{TC}{Q}$

The relationship between MC and AC is as follows :

(i) When MC < AC, then AC falls.

(ii) When MC = AC, then AC is constant (or minimum).

(iii) When MC > AC, then AC rises.

(iv) MC curve always intersects AC curve at its minimum point.

The following cost schedule and diagram illustrate the relationship:

$\begin{array}{cccc}\text{Output}& \text{TC}& \text{MC}& \text{AC}\\ \text{(in units)}& \text{(Rs)}& \text{(Rs)}& \text{(Rs)}\\ \begin{array}{c}1\\ 2\\ 3\end{array}& \begin{array}{c}5\\ 9\\ 12\end{array}& \begin{array}{c}5\\ 4\\ 3\end{array}]\text{MC}<\text{AC}& \begin{array}{c}5.0\\ 4.5\\ 4.0\end{array}]\text{AC falls}\\ 4& 16& 4]\text{MC=AC}& 4.0]\text{AC min.}\\ 5& 21& 5]\text{MC}>\text{AC}& 4.2]\text{AC rises}\end{array}$

The above schedule and diagram show that so long as MC curve lies below AC curve, AC curve is falling. This is up to point M. When AC = MC, AC is minimum. MC curve always intersect AC at its minimum point. This occurs at point Q. When MC curve lies above the AC curve, AC starts rising. This is after point Q.

For a small portion, i.e., (AB), AC curve may fall when MC curve is rising as shown in figure.