- CFA Exams
- CFA Level I Exam
- Study Session 4. Economics (1)
- Reading 12. Topics in Demand and Supply Analysis
- Subject 6. Marginal Revenue, Marginal Cost, and Profit Maximization

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**CFA Practice Question**

If a firm's average per-unit costs fall as it produces a larger output, then ______

A. marginal cost must be less than average total cost.

B. marginal cost must also decline as output expands.

C. average variable cost must also decline as output expands.

**Explanation:**Average total costs increase when marginal costs are greater than average total costs. Assume the following costs: Fixed cost = 100. The marginal cost of the first unit of output equals $10 (MC1), the marginal cost of the second unit of output equals $12 (MC2), MC3 = 14. Total costs for three units of output equals FC + VC, which here equals $100 + ($10 + $12 + $14), which equals $136. Average total costs equals $136/3 or $45.333. If MC4 = $16, which is smaller than the average total cost, the average total cost will decline. Thus, total cost becomes $136 + $16 = $152, making average total cost equal $152/4 or $38. Thus, when marginal cost is smaller than average total cost, average total cost will decline.

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**User Contributed Comments**
2

User |
Comment |
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morek |
Thank you for the breakdown. I did not understand but this helped clarify the correct thought process. |

cleopatraliao |
Economies of scale?MC<ATC :D |