5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

The Firm, Profit, and the Costs of Production ‹ 109

cost is also calculated as MC =DTVC/DQ. If quantity is changing one unit at a time,

MC =DTC =DTVC.

2. Average fixed cost (AFC)is total fixed cost divided by output: AFC =TFC/Q. It con-
   tinuously falls as output rises.

3. Average variable cost (AVC)is total variable cost divided by output: AVC =TVC/Q.

4. Average total cost (ATC)is total cost divided by output ATC =TC/Q. Note that
   ATC =AFC +AVC.

Graphically Speaking

If marginal product is the slope of total product, it should be no surprise that marginal cost

is the slope of total cost, or total variable cost. We can see that marginal cost initially falls

due to specialization but soon begins to rise as more output is produced. This is the law of

increasing costs and is a direct result of the law of diminishing marginal returns to produc-

tion. Both being U-shaped curves, average variable and average total costs initially fall, hit

a minimum point, and begin to rise. Average total cost is vertically above AVC by the

amount of AFC. Figure 8.4 illustrates this.

Marginal cost and average variable and average total cost are related in much the same

way as marginal product is related to average product of labor. When the marginal cost of

producing another cup of lemonade exceeds the current average cost, the average is rising.

When the marginal cost of producing another cup of lemonade falls below the current aver-

age cost, the average is falling. Therefore, marginal cost equals average total cost at the min-

imum of ATC and equals average variable cost at the minimum of AVC.

Bridge over (Troubling) Economic Waters

Many students think that production and cost concepts are two sets of theoretical topics.

This separation creates the impression that “there’s twice as much to remember.” These

students are surprised to find out that production and cost are closely connected.

Think about it from Molly’s point of view. If the next worker employed has a high

marginal product, then the marginal cost of producing that increased product must be quite

low. When things are going well with production, they must be going well with cost. Try to see

the concepts of production and cost not as two isolated bodies of theory but as two related sets

of concepts that just need to be bridged. Let us try to build this bridge with a little algebra.

“It’s all about the
graphs... if you
can see it, you
got it.” —Cleo,
AP Student

Average and Marginal Costs

0

5

10

15

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Output

$

AFC

AVC

AT C

Marginal Cost

Figure 8.4