# Marginal cost = Average total cost

• June 16th, 2014, 10:00 AM
john8
Marginal cost = Average total cost
Hi,

Can someone please explain to non-economist the meaning and implications when marginal cost = average total cost?

Thanks.
• June 16th, 2014, 03:22 PM
Harold14370
I'm not an economist, but I'll take a shot at it.

Let's say you build a factory to make widgets. If you only make a few widgets per day, it will probably pay you to increase production. This is because your fixed costs, like investment in the factory, taxes on the building, building maintenance, etc., don't change with increased production. The only thing that changes would be that you have to hire more assembly line workers. The marginal cost is the cost per widget for the increase above what you are currently manufacturing, that is, the new worker's wages divided by the daily production of those additional workers. It's less than the average cost per all widgets, because the fixed costs are spread out over a greater number of widgets.

This will work up to a certain point. Maybe the factory is producing all it can in one shift, and you have to pay overtime at time and a half. That will increase the marginal cost to manufacture widgets. Once the marginal cost equals the average total cost, then it would not be as advantageous to increase your production.
• June 17th, 2014, 02:56 AM
john8
Harold14370,

thanks for you reply. It's a bit clearer now. I still have one more question: why it wouldn't be desirable to increase production after the point where marginal cost = average cost?
• June 17th, 2014, 06:07 AM
kojax
Quote:

Originally Posted by john8
Harold14370,

thanks for you reply. It's a bit clearer now. I still have one more question: why it wouldn't be desirable to increase production after the point where marginal cost = average cost?

Harold did a good job of explaining that, I think. If you try to hire too many workers, they'll all be tripping over each other, and not able to work effectively.

But on any production curve, there should be two points where marginal costs = average cost, not just one. The first point is the point where you've managed to clear your fixed costs. The second one comes after you've started to get diminished returns (hiring workers who are tripping over other workers.)

You don't even want to reach the second point, let alone surpass it.

You've just got to find a way to picture this in your head.
• June 17th, 2014, 07:27 AM
Harold14370
I suppose there would be a lot of things that go into your decision to increase production. If the profit margin is high, you might want to increase the production, even if the marginal cost is higher than the average costs, because you are still making a good profit. It's just an indicator. Like I said, I'm not an economist. I'm not a businessman either.
• September 3rd, 2014, 02:42 PM
gonzales56
Quote:

Originally Posted by john8
Hi,

Can someone please explain to non-economist the meaning and implications when marginal cost = average total cost?

Thanks.

Marginal cost means how much it would cost to start producing more (unit). If the cost to produce another unit is the same as the current average total cost, then all is well.

Its pretty simple.... There is a sweet spot in production. This sweet spot is in front of being able to produce more at a reduced cost and behind producing more at a higher cost. With that said, business or running one is not all about these numbers. Great for bean counting investors/bankers but, horrible to live or die by in the world of running a business.
• September 11th, 2014, 11:39 AM
Achilleas
Quote:

Originally Posted by gonzales56
Quote:

Originally Posted by john8
Hi,

Can someone please explain to non-economist the meaning and implications when marginal cost = average total cost?

Thanks.

Marginal average cost means how much it would cost to start producing more (unit). If the cost to produce another unit is the same as the current average total cost, then all is well.

Its pretty simple.... There is a sweet spot in production. This sweet spot is in front of being able to produce more at a reduced cost and behind producing more at a higher cost. With that said, business or running one is not all about these numbers. Great for bean counting investors/bankers but, horrible to live or die by in the world of running a business.

There is not such thing as Marginal average cost. What do you mean?

In theory, when MC= ATC then this is (in the long run) the starting point of the enterprise's supply curve.
*by long run I mean time after sufficiently long period so you can alter all your inputs (machines, labour, raw materials, etc)- you may forget this for now

To put it simply, just start from basics: your profit= Revenue- Total Cost
As an entrepreneur you want profit>0 thus,
[price- (average cost)]* (quantity produced) > 0, Explanation:(price*quantity= revenue, averace cost*quantity= total cost)
therefore, Price>= Average Cost (when equal, profit=0)

Now, by definition, marginal cost is the extra cost caused bye an extra produced unit (or in other words, the slope of your production cost curve). Therefore, it's common sense to assume that your price for this level of production should be at least, your marginal cost.

You need price>= average cost and price>= marginal cost. From this, you can assume that the minimum price you want to sell is when marginal cost= average cost.
I hope it comes clear that after the point where MC= AC then an enterprise can produce and sell with at least non-negative profit.

*note that in the short run, for several reasons an enterprise may choose to produce even when it's marginal cost is lower than total average cost.

In real life, supply is not a continuous function. Eg, a car industry can not choose to produce 256,8 car tires but it can choose between 200 and 300. Therefore, in a technical sense, marginal cost does not exist. But more or less, a profitable enterprise should price it's product at least where price (thus a hypothetical "marginal cost") equals the average total cost.
• September 11th, 2014, 12:16 PM
Harold14370
Quote:

Originally Posted by Achilleas
But more or less, a profitable enterprise should price it's product at least where price (thus a hypothetical "marginal cost") equals the average total cost.

I'm not sure I follow. Certainly the price has to be greater than the marginal costs, or else you will be selling the additional production at a loss. But the marginal cost could exceed the average cost, and would still be profitable. Let's say your average cost of production is 5 dollars per unit, and the price is 7 dollars so your profit is 2 dollars. You could add production capacity at 6 dollars per unit, which still is less than 7 dollars, so the additional production adds to your profit.

Now maybe this is unrealistic, because you are in competition with other manufacturers, so it's unlikely that your profit margin is big enough that you can reduce it and stay competitive. Is that it?
• September 11th, 2014, 05:26 PM
gonzales56
Quote:

Originally Posted by Achilleas
Quote:

Originally Posted by gonzales56
Quote:

Originally Posted by john8
Hi,

Can someone please explain to non-economist the meaning and implications when marginal cost = average total cost?

Thanks.

Marginal average cost means how much it would cost to start producing more (unit). If the cost to produce another unit is the same as the current average total cost, then all is well.

Its pretty simple.... There is a sweet spot in production. This sweet spot is in front of being able to produce more at a reduced cost and behind producing more at a higher cost. With that said, business or running one is not all about these numbers. Great for bean counting investors/bankers but, horrible to live or die by in the world of running a business.

There is not such thing as Marginal average cost. What do you mean?

A simple but silly error on my part and I appreciate you pointing it out. I will correct it.
• September 11th, 2014, 06:45 PM
Achilleas
Quote:

Originally Posted by gonzales56
Quote:

Originally Posted by Achilleas
Quote:

Originally Posted by gonzales56
Quote:

Originally Posted by john8
Hi,

Can someone please explain to non-economist the meaning and implications when marginal cost = average total cost?

Thanks.

Marginal average cost means how much it would cost to start producing more (unit). If the cost to produce another unit is the same as the current average total cost, then all is well.

Its pretty simple.... There is a sweet spot in production. This sweet spot is in front of being able to produce more at a reduced cost and behind producing more at a higher cost. With that said, business or running one is not all about these numbers. Great for bean counting investors/bankers but, horrible to live or die by in the world of running a business.

There is not such thing as Marginal average cost. What do you mean?

A simple but silly error on my part and I appreciate you pointing it out. I will correct it.

I guessed it was a mistype or something... np
• September 11th, 2014, 07:16 PM
Achilleas
Quote:

Originally Posted by Harold14370
Quote:

Originally Posted by Achilleas
But more or less, a profitable enterprise should price it's product at least where price (thus a hypothetical "marginal cost") equals the average total cost.

I'm not sure I follow. Certainly the price has to be greater than the marginal costs, or else you will be selling the additional production at a loss. But the marginal cost could exceed the average cost, and would still be profitable. Let's say your average cost of production is 5 dollars per unit, and the price is 7 dollars so your profit is 2 dollars. You could add production capacity at 6 dollars per unit, which still is less than 7 dollars, so the additional production adds to your profit.

Now maybe this is unrealistic, because you are in competition with other manufacturers, so it's unlikely that your profit margin is big enough that you can reduce it and stay competitive. Is that it?

Yes you're right. Maybe I was not clear. Your bottom limit is where mc= atc. Your upper limit is the sky. As long as you can sell a product at a price greater than your atc and even greater than your mc (assuming you can calculate your mc) then go for it. Of course mc can exceed atc, and the price can exceed both of them.

To be honest, the concept of marginal cost is rather problematic in real life economics (as well as each "marginal" variable). I never liked it and I guess that major corporations do not decide their pricing strategies by calculating an imaginary variable that in many cases can not even been calculated. On the other hand, average cost is of course crucial when an enterprise decides it's pricing policies.
• September 26th, 2014, 08:18 PM
rowida
MC=ATC when ATC is minimized. This point is called the break even point. The profit will be zero. When price goes up, MC=MR=P will generate profits. But when price goes down, MC=MR=P will be a loss. If the price goes down further, less than the average variable cost, the producer will shut down and go out of the market.
• September 27th, 2014, 04:32 PM
Achilleas
Quote:

Originally Posted by rowida
MC=ATC when ATC is minimized. This point is called the break even point. The profit will be zero. When price goes up, MC=MR=P will generate profits. But when price goes down, MC=MR=P will be a loss. If the price goes down further, less than the average variable cost, the producer will shut down and go out of the market.

Wrong.

When Price (P) equals (MC=MR) there is no profit. The existence of profit requires that Price will be never equal with MR. Profit requires that Price > Marginal Revenue.