Relationship To Marginal Cost
When average cost is declining as output increases, marginal cost is less than average cost. When average cost is rising, marginal cost is greater than average cost. When average cost is neither rising nor falling (at a minimum or maximum), marginal cost equals average cost.
Other special cases for average cost and marginal cost appear frequently:
- Constant marginal cost/high fixed costs: each additional unit of production is produced at constant additional expense per unit. The average cost curve slopes down continuously, approaching marginal cost. An example may be hydroelectric generation, which has no fuel expense, limited maintenance expenses and a high up-front fixed cost (ignoring irregular maintenance costs or useful lifespan). Industries where fixed marginal costs obtain, such as electrical transmission networks, may meet the conditions for a natural monopoly, because once capacity is built, the marginal cost to the incumbent of serving an additional customer is always lower than the average cost for a potential competitor. The high fixed capital costs are a barrier to entry.
- Minimum efficient scale / maximum efficient scale: marginal or average costs may be non-linear, or have discontinuities. Average cost curves may therefore only be shown over a limited scale of production for a given technology. For example, a nuclear plant would be extremely inefficient (very high average cost) for production in small quantities; similarly, its maximum output for any given time period may essentially be fixed, and production above that level may be technically impossible, dangerous or extremely costly. The long run elasticity of supply will be higher, as new plants could be built and brought on-line.
- Zero fixed costs (long-run analysis) / constant marginal cost: since there are no economies of scale, average cost will be equal to the constant marginal cost.
Read more about this topic: Average Cost
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