If marginal cost is increasing, average costs could be rising, falling, or constant. The direction of average costs depends on whether marginal cost is higher or lower than average cost at that level of output.
To understand this better, let’s break it down:
- Marginal Cost (MC): This is the cost of producing one additional unit of a good. If this cost is increasing, it means that each additional unit is becoming more expensive to produce.
- Average Cost (AC): This is the total cost divided by the number of goods produced. It reflects the overall cost per unit.
When MC is increasing, we consider two scenarios:
- If MC is less than AC, the average cost will continue to fall as more units are produced. This is because producing an additional unit is cheaper than the average cost of the units already produced.
- If MC is greater than AC, then the average cost will start to rise. This means that the cost of producing an additional unit exceeds the average cost of the units made before it.
Therefore, the relationship between marginal and average costs gives us insight into how overall costs will behave as production volume changes. In summary, while an increasing marginal cost signals that producing each additional unit is becoming more expensive, the impact on average cost depends on the relationship between marginal cost and average cost at that level of output.