Suppose it costs $500 to make 10 widgets, or $506 to make 11 widgets.

The MarginalCost of the eleventh widget is $6 / widget.  This is the extra (incremental) cost of making the last widget.

The AverageCost of 10 widgets is $500 / 10 widgets = $50 / widget.

The AverageCost of 11 widgets is $506 / 11 widgets = $46 / widget.

The AverageCost declines (with increasing numbers of widgets) when the MarginalCost is less than the AverageCost.


See also:  CategoryEconomics, CategoryManufacturing, AnalogyBetweenProgrammingAndManufacturing, MarginalUtility, SunkCost