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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.

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Solution

Marginal cost is an addition made to total cost by producing an extra unit of output. It is expressed as : MC=ΔTCΔQ or TCn−TCn−1 Average cost is obtained by dividing the total cost by the units of output. It is expressed as: AC =TCQ 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: OutputTCMCAC(in units)(Rs)(Rs)(Rs)1235912543⎤⎥⎦MC<AC5.04.54.0⎤⎥⎦AC falls4164]MC=AC4.0]AC min.5215]MC>AC4.2]AC rises 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.

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