Math and Arithmetic
Business and Industry

What is the relationship between marginal cost and average total cost?

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January 04, 2010 1:37PM

Marginal cost is the cost incurred in producing an additional unit of a product. It is the cost per unit of a product as against the total cost. It is therefore the variable cost of producing one more unit of a product.

Average total cost is the total cost of production at an activity level. it is the total cost of divided by the total production.

Whiles marginal cost shows the cost incurred in producing an additional unit of a product, average cost shows the total cost of production per unit.

Just a small addition to this thought:

Think of the marginal cost as being at a point in time, whereas the average total cost is calculated over a period of time. As a result, marginal cost at any given point may be higher or lower than an average total cost.

Quick example:

ABC manufactures a product they call Widget A

Widget A sells for a price of $20

ABC sells 1,000 units of Widget A

Fixed costs for this production run are $5,000, regardless of # of units sold

Variable costs are $12 per unit

Gross Revenues $20,000

Fixed Cost Expense $ 5,000

Variable Cost Expense $12,000

Gross Profit $ 3,000

Breakeven # of units can be calculated as follows:

20x = 5000 + 12x. Solving for x gives 625 units to break even. At this point the Average Transaction Cost equals the selling price of $20 per unit. As each additional unit is produced the ATC will decrease since the only additional cost is the variable cost of $12 per unit. Therefore, in this very simple example, the MARGINAL COST of producing each unit OVER 625 would be the $12 variable cost expense. In the example above, at 1,000 units the Average Transaction Cost is $17 ($5 per unit for Fixed and $12 per unit for Variable), which is a decrease from the $20 ATC at break even.