Final answer:
In business, firms often analyze average cost and marginal cost to make production and pricing decisions. Average cost helps determine profitability compared to selling price, while marginal cost informs decisions on whether to increase or decrease production based on the cost of additional units.
Step-by-step explanation:
To understand the costs faced by a firm, we must consider average cost and marginal cost. Average cost (AC) is defined as the total cost (TC) divided by the quantity of output produced (Q), which gives us AC = TC | Q. In the provided example, if two widgets cost $44 in total, the average cost is $22 per widget. On the other hand, marginal cost (MC) represents the cost of producing one additional unit of output and is calculated as the change in total cost (ΔTC) divided by the change in quantity (ΔQ). If the cost for one widget is $32.50 and for two widgets it's $44, the marginal cost of the second widget is $44 - $32.50 = $11.50.
A firm not making a profit when the price is less than the average cost is evident from the scenario where, at an output of five units, the average cost is $26/unit but the price is only $25/unit. This results in a loss of $1 for each unit produced. Furthermore, with marginal costs at $30/unit and the price at $25/unit for five units, the marginal unit decreases profits, indicating that production should be reduced.