303 Marginal Costs & Average Costs Curves

Welcome to the next part of cost curves! This is where it starts to get challenging but fear not, because if we do it together, I’m sure we will overcome it!

We have derived the Short Run & Long Run Total Cost Curves from the Isocost & Isoquant. And now, we will derive from the Total Cost curves the Marginal and Average Cost curves!

Why are we studying cost curves and tearing the hair off our heads to master drawing them? These will come in handy in chapter 4 when we talk about market structures! And when we talk about markets, we talk about firms! When we talk about firms, we talk about their behaviour towards costs! Costs will change and we must be able to illustrate those changes graphically before we attempt any analysis!

This lesson will be broken into 2: Drawing the cost curves and the dynamics of the curves.

At the end of these videos, you should be able to:

  • Be proficient in drawing the LRAC, LRMC, SRAC and SRMC in the same graph.
  • Understand how to calculate marginal cost and average cost, including the shape of the curves and their behavior.
  • Understand how and why the SRAC meets the LRAC in 3 different ways.
  • Understand what shifts and changes the AC and MC curves.
  • Understand the difference between a change in variable production cost and per unit taxation.

*** Please take note that Per Unit Tax is not exactly a Variable cost. Please watch the video below to understand why.

Notes:

Average Cost = Gradient of Ray from origin to TC curve

Marginal Cost = Gradient of Tangent line on TC curve

Steps to draw LRAC, LRMC, SRAC & SRMC:

  1. Identify minimum LRAC
  2. Draw LRAC
  3. Idenfity minimum SRAC and intersection point with LRAC (Always where LRTC=SRTC)
  4. Draw SRAC
  5. Draw LRMC
  6. Identify where LRMC meets SRMC (Always where LRTC=SRTC)
  7. Draw SRMC

Position of SRAC:

  1. Min of SRAC right side of SRAC=LRAC. (LRAC=SRAC)>(LRMC=SRMC). Increasing Returns to scale
  2. Min of SRAC left side of SRAC=LRAC. (LRAC=SRAC)<(LRMC=SRMC). Decreasing Returns to scale
  3. Min of SRAC on min of LRAC. (LRAC=SRAC)=(LRMC=SRMC). Constant Returns to scale

Additional Learning Material:

This is important to know! We apologize for the gangsterish tone. First video we made. lol! 🙂

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Author: admin

30 Comments

  1. Hi, do you’ve a facebook fan page for your blog?

  2. Many thanks for rumbeling some misconception. Cannot delay to truly see the every one of them!

  3. John UK says:

    how come total cost for 2units is 20$ and for 3units is 35 $?

    • Quickienomics says:

      Hi John,

      That was just an example to illustrate marginal cost. In reality some costs get lower as we purchase or produce more. ie. bulk discounts, etc.

  4. Jimmy says:

    Wah Gerald, Salute you on the amount of Effort and Neatness put into your webpage:) IT will be great if u can share more into pure Micro economics haha:) Obligopoly, stackelberg, bertrand , Game theory, etc:)

    • Quickienomics says:

      Hi Jimmy! Thank you so much! 🙂 I’m taking managerial instead though. I would like to find out what you guys learn for micro!

  5. Dave says:

    Hi! Your first video, at 08.51, i understand that the SRMC touches the LRMC at the first point since they share the same tangent but how is the 2nd point the min of SRAC?

    • Quickienomics says:

      Hi Dave,

      That’s because if you used your ruler to act as a ray from the origin to the SRTC, you will realize that the lowest point is not the same as where the SRTC meets the LRTC. And When I say lowest point, it means the flattest ray you can find.

  6. stas says:

    Hi, first of all a huge thank you for doing all this work. Without guys like you and Boon Pin this unit would be a complete disaster.. With your explanations this stuff actually makes sense.

    Now about video 3, your equation for TC is a quadratic one, deriving a linear one for AC. I think this is possibly an error? Judging the shapes of the curves TC should be cubic, and AC quadratic. I followed your logic, and it all seems to apply still.. but the choice of equations puzzles me a bit. Is there something I am missing, or it was made on purpose to simplify things? Thank you.

    Rock on! Seriously this site is best help ever.

    • Quickienomics says:

      Hello! Thank you so much for the awesome comment! I find it very motivating and supportive! 🙂 You rock!

      Yea, regarding that video, I just used a simple equation for illustration because a cubic one would be pretty confusing. 🙂

      Here’s wishing you all the best! 🙂

      • stas says:

        Thanks a lot man! You’ve put my mind to rest 🙂 Half way through chapter 4 now. Wishing it were you who wrote the study guide haha.

        • Quickienomics says:

          Hahaha I’m glad I could help. Nah, Amos Witztum is a very bright professor. He evoked a lot of critical thinking in me when he came to Singapore to conduct the revision workshops.

  7. Romona says:

    In this exam question, I had trouble with the MR curve – I know it is a straight line, but when the question said, “Suppose that the level of output where the switch occurs (x bar) is such that marginal cost intersects marginal revenue twice” I kept trying to figure out how could MR intersect MC at x bar while it is a straight line…. am I the only one who got confused about this?

    Thanks,
    Romona

    • Quickienomics says:

      Hi Romona!

      No problem, I think I was a little unsure about this too but if you think through it systematically, it will materialize for you. And I think the question also states constant marginal cost right?

      Lemme show you how the graph should look like.
      Click here for graph!

      I hope that helps Romona. The MC intersecting MR twice is indicated with the blue circle.

  8. Romona says:

    Thanks, but you see, while it intersects twice, it is not at x bar i.e, it intersects MC1 before X bar and intersects MC2 after x bar….

    • Quickienomics says:

      Hi Romona,

      The question says that the switch occurs at X bar, which means that MC changes at X bar. It does not imply that the MC intersects MR twice at X bar.

  9. Romona says:

    Yeah, thanks, I just couldn’t get that one straight in my head…. 🙂

  10. Romona says:

    So my friend, these talking teddy bears have come back to haunt me :). Looking at the answer given in the exam commentary, it is written, “It is fairly easy to see that in this case, even though the upper triangle is smaller than the lower one, the additional shaded area at M’ seems to be larger than the upper part of the rectangle with vertical stripes. Hence, even though the operational PROFITS at B (or M’) were greater, the overall profits were smaller.” I have capitalised PROFITS as I don’t understand this – how could the overall profits be smaller? Is there a typo mistake in the answer?

    Thanks!
    Romona

  11. Romona says:

    Another question – I am becoming a regular bug! What about the deadweight loss area if production was at point A – shouldn’t this be all of the yellow area + the green area + blue triangle + white triangle above the blue one?

    Thanks again!
    Romona

  12. Ella says:

    HI,
    What a great job you are doing, this is really helpfull!
    I wonder if you can help me with this question.
    I the short run, fixed costs are 16000 and the variable costs are a function of output = x3 (to the power of 3). Questions says that there will never be a price at which the firm will have to stop its operations immediately. is this true or false?
    How whould I need to approcach this question?

    Many thanks in advance.

    • Quickienomics says:

      Hi Ella,

      Please forgive me for the late response. Approaching this question requires you to set up the total cost function for the firm.

      Total Costs = Total Fixed costs + Total Variable costs = 16000 + x^3

      We know that in order for the firm to produce in the short run, it has to be able to sell the good at a price to cover its variable costs so that it can recover its fixed cost in the long run. Therefore, as long as P is more than AVC (average variable cost), the firm can continue to produce.

      To find P, we know that a firm produces that P=MC. Differentiating the Total Cost function with respect to x gives me MC.

      MC= 3x^2

      To find AVC, simply divide the total variable cost by x.

      AVC= x^2

      As we can see, for any value of x, MC>AVC by 3 times. This implies that P>AVC.

      Therefore, there will not be any price that will cause the firm to stop operations immediately in the short run.

      I hope that helps.

  13. Dania says:

    hi, I would like to ask if there are lump sum tax, how do u shift the MC and AC? how about the change in fixed cost, is it gonna affect any cost curves?

    • Quickienomics says:

      The AC curve will shift upwards. The MC curve remains unaffected because the cost increment for an additional unit remains the same. Therefore, all fixed cost changes affect only the AC curve.

  14. ella says:

    Hi,

    in the video on per unit tax you have moved the AC curve up.
    in the case of tax per unit i thought we first move the MC curve?
    thanks

  15. Emily says:

    Hi, is there a tutorial on perfect competition and monopoly/monopolistic competition?

  16. jojo says:

    hi,
    in your 303 video where you stated when LRAC=SRAC is higher than LRMC=SRMC its increase return to scale
    why is average cost> marginal cost increase return to scale?