Key terms
- Average cost
- Average cost is total cost divided by the quantity of output produced, the cost on average of each unit made.
- Marginal cost
- Marginal cost is the additional cost of producing one more unit of output, the change in total cost divided by the change in output.
Average cost falls at first because fixed costs are spread over more units
Average total cost starts off high, because at low levels of output total costs are dominated by the fixed cost. It then declines as the fixed costs are spread over an increasing quantity of output. With still more output, average cost begins to rise, because total costs start rising more rapidly once diminishing returns come into effect. So average cost curves are typically U-shaped.