[MUSIC] Here is a red flag. Are used these flags sometimes when I really, really, really want to make an important point, here it is. The concept of marginal cost is one of the most essential in microeconomics. As we shall learn in a later chapter competitive firms will produce at alevel where the price of the product equals their marginal cost. And in that same lesson, we'll also learn that the supply curves is actually that portion of the marginal cost curve above the average variable cost curve. So perhaps you can see how this lecture provides you with a lot of valuable nuts and bolts for future use. [SOUND]. Now let's complete our short run cost analysis table by introducing the final three columns in our table. For average fixed cost, average variable cost and average total cost. These columns are simply derived by calculating averages using columns one through four and the formulas in the table. Using the formulas, try filling in the question marks now. The interesting thing about these three [SOUND] columns is the graph we can draw from them and our now old friend, marginal cost. Look at this graph carefully, and try to answer these questions. Why does the AFC curve slope downward and approach zero on the horizontal axis, while the AVC curve approaches the ATC curve. The AFC curve approaches zero because as a firm's output increases, it spreads its fixed costs over a larger number of units. So average fixed costs must fall. For the same reason the AVC curve must approach the ATC curve as output increases. These are important insights in business, because the name of the game is often to spread your fixed costs over as many units as possible. Now, here's a trickier question. We know why the ATC, AVC, and MC curves slope first down and then up. It's the law of diminishing returns, remember? But why the does the MC curve intersect both the AVC and AC curves at their minimums? Take a minute to try and write down your answer. The answer lies in these formulas, if MC is greater than ATC, then the ATC must be rising and vise versa. Think of it this way. If the production of an additional unit has a marginal cost greater than the average cost. Then production of that unit must drive the [SOUND] average up, and conversely. Thus, it must be that only when MC equals ATC that the ATC is at its lowest point. This is a critical relationship. It means that a firm searching for the lowest average cost of production should look for the level of output at which marginal cost equals average cost. To better understand this relationship, study the curves in this figure for a moment. Note that there is a small range, Area B, where average cost is falling and average variable cost is rising. Now here's the punchline. [SOUND] When marginal cost is coupled with the concept of marginal revenue, that we will introduce in the next lecture The firm is able to determine if it is profitable to expand or contract its production level. In fact, the analysis in the next several lectures centers on these types of marginal calculations. That's why learning these nuts and bolts concepts now is so important. [SOUND] And this completes our exploration of short run cost analysis.