question_answer

Define marginal cost. Explain its relation with average cost.

Or

Define variable cost. Explain the behaviour of total variable cost as output increases.

Answer:

Marginal cost is defined as the additional cost to the Total Cost, which is incurred for producing one additional unit of output. Algebraically,

\[M{{C}_{n}}=T{{C}_{n}}-T{{C}_{n-1}}\]

Average Cost is defined as per unit cost of producing output. It is derived by dividing total cost by quantity of output produced. That is,

\[AC=\frac{TC}{Q}\]

With the increase in output, both A C and MC fall. However, MC falls faster than AC and the MC curve remains below the AC curve. MC reaches its minimum point faster than AC and starts rising. When MC starts rising AC is still falling. MC curve cuts the AC curve at its minimum. When AC starts rising, it rises at a slower rate and AC curve remains below MC curve.

Relationship between AC and MC is explained with the help of the following diagram.

Relationship between AC and MC:

When AC is falling, MC falls at a faster rate; and MC remains below AC curve.

When AC is rising, MC rises at a faster rate; and MC remains above AC curve.

When AC is at its minimum point, MC is equal to AC.

MC curve cuts AC curve at its minimum point.

Or

Variable costs refer to the costs which are incurred by a firm on the variable inputs for production.

The variable costs are positive function of output i.e., as output increases, variable costs also increases and vice - versa.

That is, as more and more units of variable factor (such as labour) are employed to produce higher units of output, the variable costs rises. Initially, with the increase in output, total variable cost increasing at a diminishing rate. With further increase in output, the total variable cost starts increasing at an increasing rate.

In the figure above, output is shown on x-axis and total variable cost (TVC) on the Y axis. With the increase in output, total variable cost increases at a diminishing rate till point Z. Beyond point Z, with further increase in output, the total variable cost increase with increasing rate.