## Production Cost

Read this section on production cost. It will provide you with the needed definitions and some mathematical analysis of the topics for Unit 5.

### Average and Marginal Cost

Marginal cost is the change in total cost when another unit is produced; average cost is the total cost divided by the number of goods produced.

#### LEARNING OBJECTIVES

Distinguish between marginal and average costs

#### KEY TAKEAWAYS

##### Key Points
• The marginal cost is the cost of producing one more unit of a good.
• Marginal cost includes all of the costs that vary with the level of production. For example, if a company needs to build a new factory in order to produce more goods, the cost of building the factory is a marginal cost.
• Economists analyze both short run and long run average cost. Short run average costs vary in relation to the quantity of goods being produced. Long run average cost includes the variation of quantities used for all inputs necessary for production.
• When the average cost declines, the marginal cost is less than the average cost. When the average cost increases, the marginal cost is greater than the average cost. When the average cost stays the same (is at a minimum or maximum), the marginal cost equals the average cost.

##### Key Terms
• marginal cost: The increase in cost that accompanies a unit increase in output; the partial derivative of the cost function with respect to output. Additional cost associated with producing one more unit of output.
• average cost: In economics, average cost or unit cost is equal to total cost divided by the number of goods produced.

#### Marginal Cost

In economics, marginal cost is the change in the total cost when the quantity produced changes by one unit. It is the cost of producing one more unit of a good. Marginal cost includes all of the costs that vary with the level of production. For example, if a company needs to build a new factory in order to produce more goods, the cost of building the factory is a marginal cost. The amount of marginal cost varies according to the volume of the good being produced. Economic factors that impact the marginal cost include information asymmetries, positive and negative externalities, transaction costs, and price discrimination. Marginal cost is not related to fixed costs. An example of calculating marginal cost is: the production of one pair of shoes is $30. The total cost for making two pairs of shoes is$40. The marginal cost of producing the second pair of shoes is \$10.

#### Average Cost

The average cost is the total cost divided by the number of goods produced. It is also equal to the sum of average variable costs and average fixed costs. Average cost can be influenced by the time period for production (increasing production may be expensive or impossible in the short run). Average costs are the driving factor of supply and demand within a market. Economists analyze both short run and long run average cost. Short run average costs vary in relation to the quantity of goods being produced. Long run average cost includes the variation of quantities used for all inputs necessary for production.

#### Relationship Between Average and Marginal Cost

Average cost and marginal cost impact one another as production fluctuate:

Cost curve: This graph is a cost curve that shows the average total cost, marginal cost, and marginal revenue. The curves show how each cost changes with an increase in product price and quantity produced.

• When the average cost declines, the marginal cost is less than the average cost.
• When the average cost increases, the marginal cost is greater than the average cost.
• When the average cost stays the same (is at a minimum or maximum), the marginal cost equals the average cost.