Solution:

Total, Average, and Marginal Costs:

Total costs:

• Total cost is made up of both the fixed cost and the variable cost. They are represented in the following diagram. OX and OY are the two axes, along OX is represented the quantity produced, and OY is the cost.

• FC, a straight horizontal line represents the fixed cost and the the area above is the variable cost so the TC is the total cost curve.

  

• The average cost at any output = total cost / Units of output

Average Cost:

• The average cost is the sum of average variable cost and average fixed cost; it is also called average total cost. If the total cost of producing 60 units of goods is 2400 rupees, then the average cost. will be,

  $2400 / 120 = 20$

Marginal Cost:

• Marginal cost is the cost of producing an additional unit of output. In other words, marginal cost is the addition made to the total cost by producing one more unit of output.

• For For example, if the total cost of producing 120 units is 2400 rupees and the total cost of producing 121 units are 2436 rupees, the marginal cost, in this case, will be equal to 36 rupees.

• The concepts of the total cost, average cost, and marginal cost can be understood easily from the following table;

  

• It is evident from the above table that the marginal cost of the second unit has been derived by subtracting Rs60 from Rs80 (80-60) =20.

• Marginal costs of subsequent units are obtained in the same manner. Hence Marginal cost is the addition made to the total cost at each step.

The following diagram shows the average – marginal cost relationship:

• In the above figure, A represents the average cost and M represents the marginal cost. It can be seen that when the marginal cost (M) is above the average cost (A), the average cost rises which is shown by the rising arrow.

• On the other hand, when the marginal (M) is below the average cost (A), than the average cost falls, as is shown by the falling arrow. But when the marginal cost is the same as the average cost remains constant, as if M is pulling A along horizontally.

• The curve can be drawn to represent costs. The marginal cost (MC) and the average cost (AC) are shown in the following diagram.

  

• OX and OY are two axes, along OX are shown the quantity produced, and along OY the cost. It will be seen that as output is increased, both average cost (AC) and marginal cost (MC) fall, but MC is below AC, i.e., marginal cost is less than the average cost.

• The fall is due to the economics of scale. But beyond a point (M) i.e. when output is expanded too much, both AC and MC start rising and now MC is above AC, i.e., the marginal cost is greater than the average cost.

• That is why MC cuts AC from below at its lowest point.