Average cost measures each unit on average; marginal cost measures the extra unit.
Average cost is total cost divided by output. Average fixed and variable cost are their respective totals divided by output, so AC = AFC + AVC when output is positive. Marginal cost is the additional total cost of an extra unit, or the change in total cost divided by the output change over a stated interval. It is not the average of all costs. An additional unit costing less than the previous average pulls the average down; one costing more pulls it up. At zero output, per-unit averages are undefined.
- Average
- Average cost (AC) is total cost per unit: TC/Q. Average fixed cost (AFC) = TFC/Q and average variable cost (AVC) = TVC/Q. These averages require output above zero, and AC = AFC + AVC.
- Marginal
- Marginal cost (MC) is the extra total cost of increasing output. Calculate change in TC divided by change in Q. For one extra batch, it is simply the increase in total cost.
- Units
- Total cost is measured in dollars; average and marginal costs are dollars per unit. An average describes all units together, while a marginal value describes the extra output.
Apply the distinction
Average direction
An extra unit below the previous average pulls it down; above it pulls it up.
Smooth curves
In the usual smooth U-shaped model MC crosses AC and AVC at their minimum points. This is a relationship to interpret, not a required curve derivation.
Zero output
AC, AFC and AVC have a zero quantity denominator and are undefined.
Why short-run cost can rise faster
With a fixed input such as kitchen space, additional variable inputs can eventually add less output as crowding or bottlenecks appear. At unchanged input prices, the additional cost of output can rise. Apply the supplied cost relationship; deriving curves from production functions is not required.
| Q | AC ($/batch) | AVC ($/batch) | AFC ($/batch) | MC of added batch ($/batch) |
|---|---|---|---|---|
| 0 | - | - | - | - |
| 1 | 28.0 | 10.0 | 18.0 | 10 |
| 2 | 21.0 | 12.0 | 9.0 | 14 |
| 3 | 20.0 | 14.0 | 6.0 | 18 |
| 4 | 21.0 | 16.5 | 4.5 | 24 |
| 5 | 22.8 | 19.2 | 3.6 | 30 |
Worked example: The cost of a third batch
In the workshop schedule, total cost is $42 for two batches and $60 for three. Fixed cost is $18 at both quantities.
- At two batches, AC = 42/2 = $21 per batch. At three, AC = 60/3 = $20.
- The third batch adds $18 to total cost, so its MC is $18 per batch. It costs less than the previous $21 average and pulls that average down.
- At three batches, AFC = 18/3 = $6 and AVC = 42/3 = $14. Their sum is AC $20.
- For the fourth batch, total cost rises to $84: MC is $24, above the previous $20 average. New AC is 84/4 = $21.
Watch out for this
Marginal cost is always total cost divided by quantity.
That ratio is average cost. Marginal cost concerns the additional cost between quantities.
Check your understanding
Total cost rises from $60 at three units to $84 at four. What is the fourth unit's marginal cost?
- $21.
- $24.
- $84.