Average Cost is the cost per unit of output produced. It is also
called unit cost of production.
Average
cost
= Total cost / Output
AC
= TC / Q
Calculating AC when Total Cost is given
Units of
Output
|
Total Cost
|
AC
= TC/ Q
|
0
1
2
3
4
5
6
|
10
20
28
34
38
42
48
|
∞
20
14
11.3
9.5
8.4
8
|
Corresponding to three types of total cost in the
short run, there are three types of
average cost:
1)
Average Fixed cost
2)
Average Variable cost
3)
Average total cost
Average Total Cost is the sum total of average Fixed
cost and average variable cost.i.e.
1) Average Fixed Cost :
Average fixed cost is per unit cost of fixed factors.
Average
Fixed cost = Total Fixed cost / Output
AFC
= TFC / Q
Calculating AFC when Total Fixed Cost is given
Units of Output
|
Total Fixed Cost
|
Average Fixed cost
|
1
2
3
4
5
6
7
8
|
10
10
10
10
10
10
10
10
|
10
5
3.3
2.5
2
1.67
1.42
1.25
|
Average
Fixed Cost Curve
 |
| average fixed cost curve |
The above table and graph clearly shows that average
fixed cost goes on diminishing as output increases because the numerator of the
ratio TFC / Q is constant while the
denominator increases.
Average fixed cost cannot be negative till there is some
fixed cost.
The AFC curve slopes downwards to the right.
Downward slope of AFC shows that AFC decreases as output increases.
AFC curve is asymptotic
to the axes, i.e. the curve approaches the X axis and the Y axis at each
end.
The curve approaches X axis but never touches it because AFC cannot be
zero since the TFC is positive. Similarly, AFC curve never touches Y axis
because the TFC has a positive value at very low levels of output also. It is also important to note that AFC is a
rectangular Hyperbola. It means that if we take any point on AFC curve and
multiply AFC at that point with the corresponding level of output, the
product (AFC X output = TFC) shall
always be the same. This shows that TFC remains constant at all levels of
output.
2)
Average Variable Cost:
Average variable cost is per unit cost of variable factors.
Average
variable cost = Total variable cost / Output
AVC
= TVC / Q
Calculating AVC when Total variable Cost is given
Units of Output
|
Total Variable
Cost
|
Average
Variable cost
|
1
2
3
4
5
6
7
8
|
10
18
24
28
32
38
46
62
|
10
9
8
7
6.4
6.3
6.6
7.7
|
Average Variable cost Curve
 |
| average variable cost curve |
The above table and graph shows the behavior of AVC.
The shape of AVC is like ‘U’. Up to sixth unit of
output, it is falling. It means that as output increases, AVC tends to fall. The
curve starts rising from the seventh unit, which means that AVC begins to rise.
The AVC curve makes a ‘U’ because of the operation of Law of
Variable proportion.
In the early stages of production due to better utilization
of fixed factors, specialization and division of labour, resulting on the
increase in the efficiency of the variable factors.
Productivity increases
(increasing returns) and cost falls, so AVC curve is negatively sloped over the
early levels of production. However as the quantity of variable input goes on
increasing (overcrowding ), it becomes too much in relation with fixed factors
( optimum ratio gets disturb), also due to indivisibility of factors, efficiency
of variable factors declines.
Productivity falls (diminishing returns), thus
AVC curve is positively sloped over the later levels of production.
3) Average Total Cost :
It is the per unit cost of both fixed and variable
factors of production.
ATC
= TC / Q
= TFC
+ TVC / Q
(Since TC = TFC + TVC)
=
TFC / Q + TVC / Q
= AFC
+ AVC
ATC
= AFC + AVC
Calculating
ATC with AFC and AVC
Units of Output
|
Average Fixed
cost
|
Average Variable cost
|
ATC
|
1
2
3
4
5
6
7
8
|
10
5
3.3
2.5
2
1.67
1.42
1.25
|
10
9
8
7
6.4
6.3
6.6
7.7
|
20
14
11.3
9.5
8.4
7.97
8.02
8.95
|
Average
Variable cost Curve
 |
| average variable cost curve |
1)
ATC curve
can be obtained by adding the AFC and AVC curve also called as vertical
summation.
Vertical summation is vertically adding up the
values of AFC and AVC at different levels of output.
When output is OL
AVC = LT
AFC = LK
AC = LT + LK
= LS
Similarly for other level of output, we can find
ATC.
2) The distance between the ATC curve and AVC curve
gets smaller as production increases.
This is because in early level of outputs
AFC is a high percentage of the ATC, but
at higher level of output AFC is small percentage of the ATC.
Also the ATC curve never touches the AVC curve
because the AFC is always positive.
3) ATC curve is ‘U’ shaped. It is because of the Law
of Variable Proportion, it tends to fall owing to increasing returns to a
factor, it tend to stabilize owing to constant returns to a factor and it tends
to rise owing to diminishing returns to a factor.
4) ATC and AVC can never be equal for any level of
output.
This is because AC is the vertical summation of AVC and AFC, and AFC is
never zero owing to the fact that TFC is fixed at all levels of output.
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