Assume A Firm's Average Total Cost Equals 75 And Average Var

Assume A Firms Average Total Cost Equals 75 And Average Variable Cos

Assume a firm's average total cost equals $75 and average variable cost equals $65 at the current level of production. If the marginal cost of producing the next unit equals $60, then:

To analyze the effect of producing an additional unit on the firm's costs, we need to understand the relationships between average total cost (ATC), average variable cost (AVC), and marginal cost (MC).

Given data:

  • Average total cost (ATC) = $75
  • Average variable cost (AVC) = $65
  • Marginal cost (MC) of the next unit = $60

First, it is important to note that the average total cost (ATC) is composed of average variable cost (AVC) and average fixed cost (AFC):

ATC = AVC + AFC

Using the given values, AFC can be calculated as:

AFC = ATC - AVC = $75 - $65 = $10

This fixed cost remains constant in the short run regardless of additional production, whereas variable costs (AVC) and marginal costs (MC) change with output.

Understanding the relationship between Marginal Cost, Average Variable Cost, and Average Total Cost

Since the marginal cost of the next unit is $60, which is less than the current AVC of $65, it implies that producing the next unit will lower the average variable cost. This is because when MC

Similarly, because ATC is the sum of AVC and AFC, and AFC remains unchanged, a decline in AVC will cause ATC to decrease as well.

The shifts in costs follow the typical cost curve behaviors:

  • If MC
  • If MC > ATC or AVC, then ATC or AVC increase.

Conclusion on the Cost Movements

Given that MC = $60, which is below the current AVC of $65, both the average variable cost and average total cost will decrease with the additional production.

Therefore, the correct interpretation of the costs, based on the data provided, is that:

Average total cost will fall and average variable cost will fall.

Paper For Above instruction

The analysis of how marginal cost influences average costs is fundamental in understanding firm behavior and optimal production levels. In this context, when a firm's marginal cost (MC) of producing the next unit is less than its current average variable cost (AVC), it leads to a decrease in AVC. This phenomenon occurs because producing an additional unit at a marginal cost below the existing average pulls the average down, much like lowering the average of a set of numbers by adding a smaller number. Simultaneously, since the average total cost (ATC) includes the average fixed cost (AFC) and the average variable cost (AVC), and the AFC remains constant in the short run, a reduction in AVC naturally causes ATC to decline as well.

Given the data: ATC = $75, AVC = $65, and MC = $60, we interpret these in the context of the cost curves. The key insight is the comparison between MC and AVC. A marginal cost below the current AVC implies that producing additional output is more cost-efficient than the current average, prompting the averages to decline. This is aligned with economic theory: when MC AVC, AVC increases; and when MC equals AVC, AVC is minimized.

In this scenario, the downward movement of both AVC and ATC suggest that the firm benefits from expanding production in the short run until marginal cost equals marginal revenue (or the profit-maximizing condition). It is also important to note that the fixed costs, represented by AFC, are unaffected in the short run by the output change, reinforcing that shifts in average variable costs directly influence total costs. Thus, the strategic decision for the firm to produce more at this point is justified, as costs per unit are decreasing, potentially leading to increased profitability or market share.

Understanding these relationships plays a vital role in microeconomic decision-making, pricing strategies, and analyzing market competition. Firms constantly evaluate marginal costs temporarily below average costs to optimize production and profit margins. This fundamental principle guides the firm's short-term production adjustments and long-term capacity planning, illustrating the importance of marginal analysis in microeconomic theory. Overall, the evidence supports that both average total cost and average variable cost will fall when marginal cost is less than average variable cost, aligning with classic economic cost theory principles.

References

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