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Business 45

The document discusses average cost and how it relates to marginal cost and total cost. Some key points: - Average cost is defined as total cost divided by quantity and represents the cost per unit of producing a given quantity. - Marginal cost is the change in total cost from producing one additional unit, and does not equal average cost. - The minimum average cost occurs where the marginal cost curve is tangent to the total cost curve, known as the critical point. - At quantities before the critical point, marginal cost is below average cost, so increasing production decreases average cost. After the critical point, marginal cost exceeds average cost, so average cost increases with more production.

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Shruti Halder
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73 views4 pages

Business 45

The document discusses average cost and how it relates to marginal cost and total cost. Some key points: - Average cost is defined as total cost divided by quantity and represents the cost per unit of producing a given quantity. - Marginal cost is the change in total cost from producing one additional unit, and does not equal average cost. - The minimum average cost occurs where the marginal cost curve is tangent to the total cost curve, known as the critical point. - At quantities before the critical point, marginal cost is below average cost, so increasing production decreases average cost. After the critical point, marginal cost exceeds average cost, so average cost increases with more production.

Uploaded by

Shruti Halder
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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4.

5 AVERAGE COST 1
4.5 Average Cost
We have seen that an important principle in economics is the problem of max-
imizing profit. A second general principle involves the relationship between
the marginal cost and the average cost
C(q)
a(q) = , q > 0.
q
That is, the average cost is the cost per unit of producing a certain quantity.
It is important to notice that the marginal cost( the cost of producing the
next item) and average cost do not mean the same thing as the following
example shows.

Example 4.5.1
The cost of producing q items is C(q) = 2500 + 12q dollars.

(a) What is the marginal cost of producing the 100th item?


(b) What is the average cost of producing 100 items?

Solution.
(a) The marginal cost at the level q is given by M C(q) = C 0 (q) = 12 dollars
per unit. This means that after producing the 99 items, it costs an additional
$12 to produce the 100th item.
(b) a(100) = C(100)
100
= 2500+12(100)
100
= $37 per item

Since a(q) = C(q)


q
= C(q)−0
q−0
, a(q) is the slope of the line passing through
the points (q, C(q)) and the origin (0, 0). See Figure 4.5.1.

Figure 4.5.1
2

Minimizing a(q)
The important question in this section is the question of minimizing the
average cost function a(q). Let’s try to find the derivative of a(q). Using the
quotient rule of differentiation we obtain
C 0 (q)q − C(q) C 0 (q) − a(q)
a0 (q) = = .
q2 q
Thus, a0 (q) = 0 when C 0 (q) = a(q). So critical numbers of a(q) satisfy the
relationship C 0 (q) = a(q). In economics theory the global minimum of a(q)
occurs at a critical number of a(q). Graphically, the minimum average cost
occurs at the point on the graph of C(q) where the line passing through the
origin is tangent to the graph of C(q). See Figure 4.5.2.

Figure 4.5.2
Thus, if q0 is a critical number of a(q) then for q < q0 the marginal cost is less
than the average cost,i.e., a0 (q) < 0. This means, increasing production will
decrease the average cost. If, on the other hand, q > q0 then the marginal cost
is greater than the average cost,i.e., a0 (q) > 0. This means that increasing
production will increase the average cost.

Example 4.5.2
A total cost function, in thousands of dollars, is given by C(q) = q 3 −6q 2 +15q,
where q is in thousands and 0 ≤ q ≤ 5.

(a) Graph C(q). Estimate the quantity at which average cost is minimized.
(b) Graph the average cost function. Use it to estimate the minimum average
cost.
4.5 AVERAGE COST 3

(c) Determine analytically the exact value of q at which average cost is min-
imized.

Solution.
(a) A graph of C(q) is given in Figure 4.5.3. The average cost is minimized
at the point where the line going through the origin is tangent to the graph
of C(q). This occur at approximately q = 3.

Figure 4.5.3

(b) The average cost function is given by a(q) = C(q)


q
= q 2 − 6q + 15. The
graph of this function is given in Figure 4.5.4. Notice that the minimum
occurs at approximately q = 3.

Figure 4.5.4
4

(c) The minimum average cost occurs when C 0 (q) = a(q). That is, 3q 2 −
12q + 15 = q 2 − 6q + 15. This gives 2q 2 − 6q = 0. Solving for q we find q = 0
or q = 3. Since the average cost is not defined when q = 0, the average cost
is minimum at q = 3

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