RELATION BETWEEN AVERAGE COST AND MARGINAL COST IN SHORT RUN

Relation between AC & MC

Average Cost is simply the total cost (TC) divided by the number of units produced (Q) or it is per unit cost.

On the other, marginal cost is defined as the increment to total cost that comes from producing an increment of one unit output.

The relationship between AC and MC is illustrated in the following table and diagram.

Units of Output	TC (Rs.)	AC (RS.)	MC (RS.)
0	200	-	-
1	380	380	180
2	500	250	120
3	600	200	100
4	720	180	120
5	850	170	130
6	1020	170	170
7	1260	180	240
8	1600	200	340

Algebraically, it is the total cost of n+1 units minus the total cost of n units of output MC_n= TC_n–1.

There is a direct relationship between AC and MC curves. When AC falls MC also falls and is below AC. When AC is rising, MC also rises and is above AC. When AC is at its minimum MC equals it.

It is easier to understand the relationship with the help of Fig. This fig shows that if MC is more than AC, it pulls AC upwards. If M/c is less than AC it pushes AC downward; when MC= AC; is constant or equal to MC.

The foregoing table and diagram reveal the relationship between AC and MC as under:

i.      When MC is less than AC (or MC curve remains below AC curve), The AC falls. Example 1 to 5 units and diagram up to point B (or OM1 output shows this situation.

i.      When MC comes equal to AC, AC become constant. This is the minimum point of AC and it is at this minimum point that MC curve cuts the AC from below. See 6^th unit in the example and point B in the diagram.

ii.    When MC is higher than AC (or MC curve rises above the AC curve), AC stares to rise. It is shown as 6^th unit onwards in the example and point B onwards in the diagram.

            Thus AC-MC relationship can be summarized as under. So long as MC is below AC, it is pulling AC down; when MC gets to be just equal to AC, AC is neither rising nor falling and is at its minimum; and when MC is above AC, it is pulling AC up.

Can AC fall when MC is rising?

            It is clear from the above schedule and diagram that AC can fall even when MC is rising. The conditions is that MC may rise but it should remain below AC. so long as MC remains below AC, AC will fall even when MC is resign. For instance, from 3^rd to 5^th unit in our example and from A to B in our diagram MC is raising but even then AC is falling because during this range MC is below the AC.

AC when MC is falling

            Can AC rise when MC is falling? No, it is not possible. When marginal cost is falling, average cost cannot rise but it has to fall.

Difference between AC and MC

(i)    When MC is below the AC, AC falls and when MC is above the AC, AC rises.

(ii)   MC reaches its minimum point at a lower level of output than do the AC AVC curves.

(iii)  There is no effect of fixed costs on the MC but is affected by both fixed and variable costs.

(iv)  MC helps in determining the level of output while AC helps in determining the amount of profit or loss.