Average total cost is __ whenever marginal cost is greater than average total cost. A at its maximum B increasing C decreasing D at its minimum
The correct answer and explanation is:
The correct answer is C) decreasing.
Explanation:
When marginal cost (MC) is greater than average total cost (ATC), the average total cost is decreasing. This relationship stems from the way that marginal cost and average total cost interact. The marginal cost represents the cost of producing one additional unit of output, while the average total cost reflects the per-unit cost of producing all units up to that point.
When the marginal cost is higher than the average total cost, it means that the cost of producing the next unit is higher than the average cost of producing all previous units. As a result, the average total cost must adjust to reflect this higher cost, which causes the average to fall. This happens because the average total cost is the sum of all total costs divided by the number of units produced. If the cost of producing the next unit is higher than the average, the average must decrease to accommodate this.
This scenario typically occurs in the stage of production where a firm is experiencing increasing returns to scale, but those returns are beginning to diminish. For example, when a company expands production, it might initially benefit from economies of scale, but after a certain point, the production becomes less efficient, leading to a higher marginal cost.
However, once the marginal cost falls below the average total cost, the average total cost will start to rise. The lowest point on the average total cost curve, where it is neither increasing nor decreasing, is called the minimum average total cost. The relationship between marginal cost and average total cost is crucial in determining the firm’s optimal production level.