A cost function for a firm is a mathematical representation of the relationship between the cost of production and the quantity of goods or services produced. It helps firms make decisions about how to allocate resources and determine the most efficient level of production.
Marginal cost is the additional cost incurred by a firm to produce one more unit of a good or service. It takes into account the change in total cost divided by the change in quantity produced.
Average cost is the total cost of production divided by the quantity of goods or services produced. It is also known as the per-unit cost and includes both fixed and variable costs.
As a firm produces more units of a good or service, marginal cost typically increases while average cost decreases. This is because marginal cost reflects the additional cost of producing one more unit, while average cost considers the total cost of production divided by the quantity produced.
Understanding cost functions is crucial for a firm to make informed decisions about production levels, pricing strategies, and resource allocation. It allows firms to identify the most efficient level of production and minimize costs, ultimately leading to higher profits and competitive advantage in the market.