Source of diagram: www.revisionguru.co.uk
Student’s question: What is the relation between the marginal cost (MC) curve & average cost (AC) curve?
This is one of the most popular questions that students ask me. It is under Industrial Economics for those who are taking Edexcel examination & under Business Economics for those taking Cambridge. The following analysis, is based on diagram above. Our concern is on MC & AC only. Ignore AFC & AVC (so difficult to find diagram with only MC & AC)
Let me illustrate. Say there are 9 students & coincidentally each of them has RM 20. This means average amount of money that each student has also RM 20. When the 10th student which has only RM 10 joins the group, total amount of money is RM190 & of course the new average is RM19. Here, the average went down because the amount he added to the total which is the marginal was actually less than the average
That’s why when MC < AC, AC will go down (pull the average down)
On the other hand, say the 10th student carries with him RM 100, the total amount of money is RM 280 & the new average is RM 28. Here the average went up because the amount he added to the total which is the marginal (increase of RM 100) was far higher than the average of RM 20.
Therefore we conclude, when MC > AC, AC will go up (pull the average up)
If the tenth student brings with him only RM20 just like the others, then there is no change in average amount of money. This is because marginal increase equals to original average. That is new total amount of money is RM200, divided by 10 students & still each is RM20.
So, when MC = AC, AC will not change (does not affect the original average)