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Is Average Variable Cost a Good Proxy for Short-Run Marginal Cost and Why is it Important?

Author

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  • Michael Olive

    (Department of Economics, Macquarie University)

Abstract

Average variable cost is often used as a proxy for short-run marginal cost in empirical studies of manufacturing firm behaviour. Assuming that average variable cost is equal to marginal cost, Cowling and Waterson (1976) derive a model that links industry structure to the industry price-cost margin and Areeda-Turner (1975) provide a test of predatory pricing. However, the research on the relationship between average variable cost and short-run marginal cost mainly comes from survey studies. This paper employs a supply relation similar to Bresnahan's (1982) in order to estimate industry marginal cost divided by industry average variable cost (MC/AVC) for 89 four-digit Australian manufacturing industries during 1971 to 1984. The 3SLS results indicate that MC/AVC is not significantly different from one in 40 percent of industries, but is cyclical in only 30 percent of industries. This suggests that industry average variable cost multiplied by a constant can be used as a proxy for industry marginal cost for a large number of industries over a short period.

Suggested Citation

  • Michael Olive, 2002. "Is Average Variable Cost a Good Proxy for Short-Run Marginal Cost and Why is it Important?," Research Papers 0208, Macquarie University, Department of Economics.
    • Handle: RePEc:mac:wpaper:0208
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    File URL: http://www.econ.mq.edu.au/research/2002/8-2002Olive.PDF
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    More about this item

    Keywords

    marginal cost; average variable cost; manufacturing; supply relation;
    All these keywords.

    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L6 - Industrial Organization - - Industry Studies: Manufacturing

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