Firms, according to the analysis we use predict their behaviour, are very interested in their marginal cost. Since the term marginal means additional or incremental, marginal costs refer to those costs that result from a one-unit change in the production rate. We find marginal cost by subtracting the total cost of producing all but the last unit from the total cost of producing all units, including the last one. Marginal costs can be measured, therefore, by using the formula:
Marginal Cost = Change in Total Cost ÷ Change in Total Output
Average Fixed Costs (AFC) : they continue to fall throughout the output range. The gap between ATC and AVC = AFC
Average Variable Costs (AVC) : the form it takes is U-shaped: first it falls; then it starts to rise. It is certainly possible to have other shapes of the AVC.
Average Total Costs or Average Costs (ATC or AC) : similar shape to the average variable cost. However, it falls even more dramatically in the beginning and rises more slowly after it has reached a minimum point. It falls and then rises because average total costs is the summation of the AFC and the AVC curve. Thus, when AFC plus AVC are both falling, it is only logical that ATC would fall, too. At some point, however, AVC starts to increase while AFC continues to fall. Once the increase in the AVC outweighs the decrease in the AFC curve, the ATC curve will start to increase and will develop its familiar U-shape. Where MC = ATC this is the lowest point on the ATC curve and is therefore the cheapest production for the firm. This is called the technical optimum.
Marginal Cost (MC) : it cuts ATC and AVC at their lowest points. The firm will supply where the price is greater than or equal to MC. Thus the individual firm’s supply curve consists of the firm’s MC curve, but only the portion above AVC. The reason for this is that where P=AVC the firm will shut down operations because they are barely covering avoidable costs.