Is this true or false? Average total cost falls as output rises if marginal cost is less than average variable cost.

It is true that average total cost falls as output rises in this scenario. If the marginal cost of producing an extra unit of output is less than the average variable cost, an increase in output will pull the average variable cost down. When average variable costs fall, average total costs fall as well.

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This statement should be true in the short term. To understand why, you must first understand what makes up total cost. Total cost is the sum of the variable costs and fixed costs for producing a good or service. Variable costs are the costs that change with the amount of good or service produced (e.g., materials, labor hours, etc.). Fixed costs are the costs that must be paid no matter the quantity of the good or service produced (rent, equipment purchases, etc.). Thus, the average total cost is only affected by the variable costs as output rises.

You also need to understand how marginal costs and average variable costs relate. Marginal cost is the cost of the next unit of output produced. So long as marginal cost is less than the average variable cost, each new unit produced will pull down the average variable cost. Because fixed costs stay the same, a decline in the average variable cost makes the average total cost fall (TC = FC + VC). In contrast, if the marginal cost is higher than average variable cost, each additional unit of output drives up the average variable cost and consequently, the average total cost.

You must remember, however, that in the long term, output can grow (or diminish) enough to affect fixed costs. This is why there is no such thing as fixed costs and all costs are variable in the long run.

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