Average Cost: Definition, Formula & Examples - StudySmarter

Learning Materials

• Explanations Explanations
  • Anthropology
  • Archaeology
  • Architecture
  • Art and Design
  • Bengali
  • Biology
  • Business Studies
  • Chemistry
  • Chinese
  • Combined Science
  • Computer Science
  • Economics
  • Engineering
  • English
  • English Literature
  • Environmental Science
  • French
  • Geography
  • German
  • Greek
  • History
  • Hospitality and Tourism
  • Human Geography
  • Japanese
  • Italian
  • Law
  • Macroeconomics
  • Marketing
  • Math
  • Media Studies
  • Medicine
  • Microeconomics
  • Music
  • Nursing
  • Nutrition and Food Science
  • Physics
  • Politics
  • Polish
  • Psychology
  • Religious Studies
  • Sociology
  • Spanish
  • Sports Sciences
  • Translation

Features

• Flashcards
• StudySmarter AI
• Notes
• Study Plans
• Study Sets
• Exams

Discover

• Find a job
• Student Deals
• Magazine
• Mobile App

• Explanations
• Microeconomics
• Production Cost
• Average Cost

Average Cost

Businesses produce and sell a variety of products in different market structures at different price levels. To maximize their profit in the market, they have to take the costs of the production into account as well. To understand how the firms calculate the cost functions and derive their production plan, we should have a close look at two main cost types: marginal cost and average cost. In this article, we will learn all about the average cost, its equation, and what the average cost function looks like with various examples. Ready to deep dive, let’s go!

Get started

Millions of flashcards designed to help you ace your studies

Sign up for free

• + Add tag
• Immunology
• Cell Biology
• Mo

Which one is the definition of Average variable cost (AVC)? 

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which one is the definition of Average fixed cost (AFC)?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

How does the average fixed cost change with an additional unit of production?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

How do the spreading effect and diminishing returns effect cause the U-shape of the Average Cost Function?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which is true?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which is true?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

If a firm has an average variable cost of $20 and an average fixed cost of $10, what is the average total cost?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

If a firm has an average total cost of $20 and an average fixed cost of $10, what is the average variable cost?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which economic term is used to describe the per-unit cost of production which is calculated by dividing the total cost by the total output?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Average fixed cost (AFC) shows us the total fixed cost for each unit. To calculate the AFC, we should ...

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

To calculate the average variable cost (AVC), we should ...

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which one is the definition of Average variable cost (AVC)? 

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which one is the definition of Average fixed cost (AFC)?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

How does the average fixed cost change with an additional unit of production?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

How do the spreading effect and diminishing returns effect cause the U-shape of the Average Cost Function?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which is true?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which is true?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

If a firm has an average variable cost of $20 and an average fixed cost of $10, what is the average total cost?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

If a firm has an average total cost of $20 and an average fixed cost of $10, what is the average variable cost?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Which economic term is used to describe the per-unit cost of production which is calculated by dividing the total cost by the total output?

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

Average fixed cost (AFC) shows us the total fixed cost for each unit. To calculate the AFC, we should ...

Show Answer

• + Add tag
• Immunology
• Cell Biology
• Mo

To calculate the average variable cost (AVC), we should ...

Show Answer Generate flashcards Summarize page Generate flashcards from highlight

Review generated flashcards

Sign up for free

to start learning or create your own AI flashcards

Sign up for free You have reached the daily AI limit

Start learning or create your own AI flashcards

StudySmarter Editorial Team

Team Average Cost Teachers

• 11 minutes reading time
• Checked by StudySmarter Editorial Team

Save Article Save Article Sign up for free to save, edit & create flashcards. Save Article Save Article

• Fact Checked Content
• Last Updated: 09.03.2023
• Published at: 26.08.2022
• 11 min reading time

• Asymmetric Information
• Consumer Choice
• Economic Principles
• Factor Markets
• Imperfect Competition
• Labour Market
• Market Efficiency
• Microeconomics Examples
• Perfect Competition
• Political Economy
• Poverty and Inequality
• Production Cost
• Average Cost
• Constant Returns to Scale
• Cost Accounting
• Cost Curves
• Cost Minimization
• Costs of Production
• Decreasing Returns to Scale
• Diseconomies of Scale
• Economic Cost
• Economic Profit vs Accounting Profit
• Economies of Scale
• Economies of Scope
• Fixed Costs
• Increasing Returns to Scale
• Isocost Line
• Long Run Entry and Exit Decisions
• Long Run Production Cost
• Marginal Cost
• Marginal Revenue
• Opportunity Cost of Capital
• Production
• Production Function
• Productivity
• Profit
• Profit Maximization
• Returns to Scale
• Revenue Vs Profit
• Short Run Production Cost
• Short Run Production Decision
• Specialisation and Division of Labour
• Sunk Costs
• Technological Change
• The Law of Diminishing Returns
• Total Cost Curve
• Types of Profit
• User Cost of Capital
• Supply and Demand

Contents

• Asymmetric Information
• Consumer Choice
• Economic Principles
• Factor Markets
• Imperfect Competition
• Labour Market
• Market Efficiency
• Microeconomics Examples
• Perfect Competition
• Political Economy
• Poverty and Inequality
• Production Cost
• Average Cost
• Constant Returns to Scale
• Cost Accounting
• Cost Curves
• Cost Minimization
• Costs of Production
• Decreasing Returns to Scale
• Diseconomies of Scale
• Economic Cost
• Economic Profit vs Accounting Profit
• Economies of Scale
• Economies of Scope
• Fixed Costs
• Increasing Returns to Scale
• Isocost Line
• Long Run Entry and Exit Decisions
• Long Run Production Cost
• Marginal Cost
• Marginal Revenue
• Opportunity Cost of Capital
• Production
• Production Function
• Productivity
• Profit
• Profit Maximization
• Returns to Scale
• Revenue Vs Profit
• Short Run Production Cost
• Short Run Production Decision
• Specialisation and Division of Labour
• Sunk Costs
• Technological Change
• The Law of Diminishing Returns
• Total Cost Curve
• Types of Profit
• User Cost of Capital
• Supply and Demand

Contents

• Fact Checked Content
• Last Updated: 09.03.2023
• 11 min reading time

• Content creation process designed by Lily Hulatt
• Content sources cross-checked by Gabriel Freitas
• Content quality checked by Gabriel Freitas

Sign up for free to save, edit & create flashcards. Save Article Save Article

Jump to a key chapter

Average Cost Definition

Average Cost, also called average total cost (ATC), is the cost per output unit. We can calculate the average cost by dividing the total cost (TC) by the total output quantity (Q).

Average Cost equals the per-unit cost of production, which is calculated by dividing the total cost by the total output.

Total cost means the sum of all costs, including fixed and variable costs. Therefore, average Cost is also often called the total cost per unit or the average total cost.

For example, if a company produces 1,000 widgets at a total cost of $10,000, the average cost per widget would be $10 ($10,000 ÷ 1,000 widgets). This means that on average, it costs the company $10 to produce each widget.

Average Cost Formula

The average cost is important for firms since it shows them how much each unit of output costs them.

Remember, marginal cost shows how much an additional unit of output costs the firm to produce.

\(\hbox{Average total cost}=\frac{\hbox{Total cost}}{\hbox{Quantity of output}}\)

We can calculate the average cost using the following equation, where TC stands for the total cost and Q means the total quantity.

The average cost formula is:

\(ATC=\frac{TC}{Q}\)

How can we calculate the average cost using the average cost formula?

Let's say the Willy Wonka chocolate firm produces chocolate bars. Their total costs and different levels of quantity are given in the following table. Using the average cost formula, we divide the total cost by the corresponding quantity for each level of quantity in the third column:

Table 1. Calculating Average Cost
Total Cost ($)	Quantity of Output	Average Cost ($)
3000	1000	3
3500	1500	2.33
4000	2000	2

As we see in this example, we should divide the total cost by the quantity of output to find the average cost. For instance, for a total cost of $3500, we can produce 1500 chocolate bars. Therefore, the average cost for the production of 1500 chocolate bars is $2.33. This demonstrates average cost decreasing as the fixed costs are spread between more output.

Components of the Average Cost Equation

The average total cost equation breaks into two components: average fixed cost, and average variable cost.

Average fixed cost formula

Average fixed cost (AFC) shows us the total fixed cost for each unit. To calculate the average fixed cost, we have to divide the total fixed cost by the total quantity:

\(\hbox{Average fixed cost}=\frac{\hbox{Fixed cost}}{\hbox{Quantity of output}}\)

\(AFC=\frac{FC}{Q}\)

Fixed costs are not connected to the quantity of produced output. Fixed costs the firms have to pay, even at a production level of 0. Let's say a firm has to spend $2000 a month for rent and it does not matter whether the firm is active that month or not. Thus, $2000, in this case, is a fixed cost.

Average variable cost formula

Average variable cost (AVC) equals the total variable cost per unit of produced quantity. Similarly, to calculate the average variable cost, we should divide the total variable cost by the total quantity:

\(\hbox{Average variable cost}=\frac{\hbox{Variable cost}}{\hbox{Quantity of output}}\)

\(AVC=\frac{VC}{Q}\)

Variable costs are production costs that differ depending on the total output of production.

A firm decides to produce 200 units. If raw materials cost $300 and labor to refine them costs $500.

$300+$500=$800 variable cost.

$800/200(units) =$4 Average Variable Cost.

The average cost is the sum of the fixed cost and average cost. Thus, if we add the average fixed cost and average variable cost, we should find the average total cost.

\(\hbox{Total average cost}=\hbox{Average variable cost (AVC)}+\hbox{Average fixed cost (AFC)}\)

The Average Fixed Cost and the Spreading Effect

The average fixed cost decreases with increasing produced quantity because the fixed cost is a fixed amount. This means it does not change with the produced amount of units.

You can think of the fixed cost as the amount of money you need to open a bakery. This includes, for instance, necessary machines, stands, and tables. In other words, fixed costs equal the required investment you need to make to start producing.

Since the total fixed cost is fixed, the more you produce, the average fixed cost per unit will decrease further. This is the reason why we have a falling average fixed cost curve in Figure 1 above.

This effect is called the spreading effect since the fixed cost is spread over the produced quantity. Given a certain amount of fixed cost, the average fixed cost decreases as the output increases.

The Average Variable Cost and the Diminishing Returns Effect

On the other hand, we see a rising average variable cost. Each unit of output that the firm produced additionally adds more to the variable cost since a rising amount of variable input would be necessary to produce the additional unit. This effect is also known as diminishing returns to the variable input

This effect is called the diminishing returns effect. Since a greater amount of variable input would be necessary as the output increases, we have higher average variable costs for higher levels of produced outputs.

The U-shaped Average Total Cost Curve

How do the spreading effect and diminishing returns effect cause the U-shape of the Average Cost Function? The relationship between these two affects the shape of the Average Cost Function.

For lower levels of output, the spreading effect dominates the diminishing returns effect, and for higher levels of output, the contrary holds. At low levels of output, small increases in output cause large changes in average fixed cost.

Assume a firm has a fixed cost of 200 in the beginning. For the first 2 units of production, we would have a $100 average fixed cost. After the firm produces 4 units, the fixed cost decreases by half: $50. Therefore, the spreading effect has a strong influence on the lower levels of quantity.

At high levels of output, the average fixed cost is already spread over the produced quantity and has a very small influence on the average total cost. Therefore, we don't observe a strong spreading effect anymore. On the other hand, diminishing returns generally increase as quantity rises. Therefore, the diminishing returns effect dominates the spreading effect for a large number of quantities.

Average Cost Examples

It is very important to understand how to calculate the Average Cost using the total fixed cost and average variable cost. Let's practice calculating the Average Cost and have a closer look at the example of the Willy Wonka chocolate firm. After all, we all like chocolate, right?

In the below table, we have columns for the produced quantity, the total cost as well as the average variable cost, average fixed cost, and average total cost.

Table 2. Average Cost Example
Quantity (chocolate bar)	Average fixed cost ($)	Average variable cost ($)	Total costs ($)	Average total cost ($)
1	54	6	60	60
2	27	8	70	35
4	13.5	10	94	23.5
8	6.75	12	150	18.75
10	5.4	14	194	19.4

As the Willy Wonka chocolate firm produces more chocolate bars, the total costs are increasing as expected. Similarly, we can see that the variable cost of 1 unit is $6, and the average variable cost increases with each additional unit of chocolate bar. The fixed cost equals $54 for the 1 unit of chocolate, the average fixed cost is $54. As we learn, the average fixed costs decrease as the total quantity increase.

At a quantity level of 8, we see that fixed costs have spread out across the total output($13.5). While the average variable cost is increasing($12), it increases less than the average fixed cost decreases. This results in a lower average total cost($18.75). This is the most efficient quantity to produce, as the average total cost is minimized.

Similarly, at a quantity level of 10, we can observe that despite the average fixed cost ($5.4) being minimized, the variable cost ($14) has increased as a result of diminishing returns. This results in a higher average total cost($19.4), which shows that the efficient production quantity is lower than 10.

The surprising aspect is the average total cost, which is first decreasing and then increasing as the quantity rises. It is important to distinguish between the total cost and the average total cost since the former always increases with additional quantity. However, the average total cost function has a U-shape and first falls and then rises as the quantity increases.

Average Cost Function

The average total cost function has a U-shape, which means it is decreasing for low levels of output and increases for larger output quantities.

In Figure 1, we will analyze the Average Cost Function of the Bakery ABC. Figure 1 illustrates how the average cost changes with different levels of quantity. The quantity is shown on the x-axis, whereas the cost in dollars is given on the y-axis.

Fig 1. - Average Cost Function

On the first look, we can see that the Average Total Cost Function has a U-shape and decreases up to a quantity (Q) and increases after this quantity (Q). The average fixed cost decreases with the increasing quantity and the average variable cost has an increasing path in general.

The U-shape structure of the Average Cost Function is formed by two effects: the spreading effect and the diminishing returns effect. The average fixed cost and average variable cost are responsible for these effects.

Average Cost and Cost Minizimation

At the point Q where the diminishing returns effect and the spreading effect balance each other, the average total cost is at its minimum level.

The relationship between the average total cost curve and marginal cost curve is illustrated in Figure 2 below.

Fig 2. - Average Cost and Cost Minimization

The corresponding quantity where the average total cost is minimized is called the minimum-cost output, which equals Q in Figure 2. Further, we see that the bottom of the U-shaped average total cost curve is also the point where the marginal cost curve intersects the average total cost curve. This is in fact not a coincidence but a general rule in the economy: the average total cost equals marginal cost at the minimum-cost output.

Average Cost - Key takeaways

• Average Cost equals the per-unit cost of production which is calculated by dividing the total cost by the total output.
• Average fixed cost (AFC) shows us the total fixed cost for each unit and Average variable cost (AVC) equals the total variable cost per unit of produced quantity.
• The average cost is the sum of the fixed cost and average variable cost. Thus, if we add the average fixed cost and average variable cost, we should find the average total cost.
• The average total cost function has a U-shape, which means it is decreasing for low levels of output and increases for larger output quantities.
• The U-shape structure of the Average Cost Function is formed by two effects: the spreading effect and the diminishing returns effect.
• For lower levels of output, the spreading effect dominates the diminishing returns effect, and for higher levels of output, the contrary holds.

Similar topics in Microeconomics

• Poverty and Inequality
• Microeconomics Examples
• Market Efficiency
• Factor Markets
• Imperfect Competition
• Supply and Demand
• Perfect Competition
• Labour Market
• Economic Principles
• Production Cost
• Consumer Choice
• Political Economy
• Asymmetric Information

Related topics to Production Cost

• Average Cost
• Technological Change
• Returns to Scale
• Specialisation and Division of Labour
• Costs of Production
• Cost Accounting
• Marginal Cost
• Production Function
• The Law of Diminishing Returns
• Total Cost Curve
• Opportunity Cost of Capital
• Types of Profit
• Constant Returns to Scale
• Economies of Scale
• Increasing Returns to Scale
• Short Run Production Cost
• Diseconomies of Scale
• Short Run Production Decision
• Productivity
• Long Run Production Cost
• Revenue Vs Profit
• Cost Curves
• Fixed Costs
• Marginal Revenue
• Economies of Scope
• Long Run Entry and Exit Decisions
• User Cost of Capital
• Economic Cost
• Profit Maximization
• Cost Minimization
• Decreasing Returns to Scale
• Economic Profit vs Accounting Profit
• Production
• Sunk Costs
• Isocost Line
• Profit

Flashcards in Average Cost

15 Start learning

Which one is the definition of Average variable cost (AVC)? 

The average variable cost equals the total variable cost per unit of produced quantity. 

Which one is the definition of Average fixed cost (AFC)?

The average fixed cost shows us the total fixed cost for each unit.

How does the average fixed cost change with an additional unit of production?

The average fixed cost decreases with increasing produced quantity

How do the spreading effect and diminishing returns effect cause the U-shape of the Average Cost Function?

For lower levels of output, the spreading effect dominates the diminishing returns effect, and for higher levels of output, the contrary holds.

Which is true?

The average total cost function has a U-shape, which means it increases for low levels of output and decreases for larger output quantities. 

Which is true?

If we add the average fixed cost and average variable cost, we should find the average total cost.

Learn faster with the 15 flashcards about Average Cost

Sign up for free to gain access to all our flashcards.

Sign up with Email

Already have an account? Log in

Frequently Asked Questions about Average Cost

What is the average cost?

Average Cost is defined as the cost of production per unit.

How to calculate the average cost?

Average Cost is calculated by dividing the total cost by the total output.

What is the average cost function?

The average total cost function has a U-shape, which means it is decreasing for low levels of output and increases for larger output quantities.

Why is the long-run average cost curve U-shaped?

The U-shape structure of the Average Cost Function is formed by two effects: the spreading effect and the diminishing returns effect. The average fixed cost and average variable cost are responsible for these effects.

What is an example of average cost?

The total cost of $20,000, we can produce 5000 chocolate bars. Therefore, the average cost for the production of 5000 chocolate bars is $4.

What is the average cost formula?

The average cost formula is:

Average total cost (ATC) = Total cost (TC) / Quantity of output (Q)

Save Article Test your knowledge with multiple choice flashcards

Which one is the definition of Average fixed cost (AFC)?

A. The average fixed cost equals how much an additional unit of output costs the firm to produce. B. The average fixed cost equals the total variable cost per unit of produced quantity.  C. The average fixed cost shows us the total fixed cost for each unit. D. The average fixed cost equals the per-unit cost of production.

How does the average fixed cost change with an additional unit of production?

A. The average fixed cost decreases with increasing produced quantity B. The average fixed cost stays same with increasing produced quantity C. The average fixed cost increases with increasing produced quantity

Score

That was a fantastic start! You can do better! Sign up to create your own flashcards

Access over 700 million learning materials

Study more efficiently with flashcards

Get better grades with AI

Sign up for free

Already have an account? Log in

Good job!

Keep learning, you are doing great.

Don't give up! Next Open in our app

How we ensure our content is accurate and trustworthy?

At StudySmarter, we have created a learning platform that serves millions of students. Meet the people who work hard to deliver fact based content as well as making sure it is verified.

Content Creation Process: Lily Hulatt

Digital Content Specialist

Lily Hulatt is a Digital Content Specialist with over three years of experience in content strategy and curriculum design. She gained her PhD in English Literature from Durham University in 2022, taught in Durham University’s English Studies Department, and has contributed to a number of publications. Lily specialises in English Literature, English Language, History, and Philosophy.

Get to know Lily Content Quality Monitored by: Gabriel Freitas

AI Engineer

Gabriel Freitas is an AI Engineer with a solid experience in software development, machine learning algorithms, and generative AI, including large language models’ (LLMs) applications. Graduated in Electrical Engineering at the University of São Paulo, he is currently pursuing an MSc in Computer Engineering at the University of Campinas, specializing in machine learning topics. Gabriel has a strong background in software engineering and has worked on projects involving computer vision, embedded AI, and LLM applications.

Get to know Gabriel Discover learning materials with the free StudySmarter app Sign up for free

About StudySmarter

StudySmarter is a globally recognized educational technology company, offering a holistic learning platform designed for students of all ages and educational levels. Our platform provides learning support for a wide range of subjects, including STEM, Social Sciences, and Languages and also helps students to successfully master various tests and exams worldwide, such as GCSE, A Level, SAT, ACT, Abitur, and more. We offer an extensive library of learning materials, including interactive flashcards, comprehensive textbook solutions, and detailed explanations. The cutting-edge technology and tools we provide help students create their own learning materials. StudySmarter’s content is not only expert-verified but also regularly updated to ensure accuracy and relevance.

Learn more StudySmarter Editorial Team

Team Microeconomics Teachers

• 11 minutes reading time
• Checked by StudySmarter Editorial Team

Save Explanation Save Explanation Study anywhere. Anytime.Across all devices. Sign-up for free Create a free account to save this explanation.

Save explanations to your personalised space and access them anytime, anywhere!

Sign up with Email Sign up with Apple

By signing up, you agree to the Terms and Conditions and the Privacy Policy of StudySmarter.

Already have an account? Log in

Sign up to highlight and take notes. It’s 100% free.

Get Started Free Explore our app and discover over 50 million learning materials for free. Sign up for free 94% of StudySmarter users achieve better grades with our free platform. Download now!