Question

b. Average variable cost, average fixed cost, marginal cost and average cost are necessary for the analysis of the cost structure of the firm. Define each of these terms and show how they are calculated

c. Describe the relationship between the marginal product and the total product of a firm

Answer 1

Average variable cost can be obtained by dividing total variable cost by number of units of output. Average variable cost is the total variable cost per unit of output, such as labor cost per unit, material cost per unit etc. As output increases, AVC decreases first and reaches its minimum and then starts increasing. AVC = TVC/Q AVC = average variable cost TVC = total variable cost Q = output Example: TVC = 1500 Q = 10 AVC = 1500/10 AVC = 150 Average fixed cost can be obtained by diving total fixed cost by number of units of output. Average fixed cost is the total fixed cost per unit of output. It includes land, machines etc. As output increases, average fixed cost decreases throughout the output. AFC = TFC/Q

AFC = average fixed cost TFC = total fixed cost Q = number of units Example: TFC = 1000 Q = 10 AFC = 1000/10 AFC = 100 Average cost can be obtained by dividing total cost by the number of units of output. Average cost is per unit cost. As output increases, AC decreases first and reaches its minimum and then starts increasing. ATC = AFC + AVC or ATC = TC/Q ATC = average total cost AFC = average fixed cost AVC = average variable cost TC = total cost Q = output

Example: TC = 2500 Q = 10 ATC = 2500/10 ATC = 250 Or ATC = AFC + AVC ATC = 100 + 150 ATC = 250 Marginal cost is the additional cost which is obtained by producing an extra unit of output. As output increases, AC decreases first and reaches its minimum and then starts increasing MC = TCn - TCn - 1 Or MC = change in TC/change in butput MC = marginal cost TC = total cost

n=number of units of output Example: If Q = 10, TC = 2500 If Q = 11, TC = 2700 Thus, MC will be MC = 2700 - 2500 MC = 200 Total product is total units of output by using all factors of production. Marginal product is the additional output by using an extra unit of input. Relationship between marginal product and total product: In the short run, when marginal product increases, total product increases at an increasing rate. When marginal product decreases, total product increases at a decreasing rate. When the marginal product becomes zero, total product reaches its maximum. When the marginal product becomes negative, total product decreases at a negative rate.

Graph: Output TP maximum MP-0 Labor units MP