Average costs divide each total by output: ATC = TC / Q, AFC = FC / Q, AVC = VC / Q.
Average cost is the cost of each unit. Average total cost (ATC) = TC / output. Average fixed cost (AFC) = FC / output. Average variable cost (AVC) = VC / output. Also, ATC = AFC + AVC.
As output rises, AFC always falls. The same fixed cost is shared across more units. This is called spreading the fixed cost.
AVC usually falls at first, as workers specialise and machines are used fully, then rises as the firm gets crowded and less efficient. So ATC is U-shaped.
Firms watch ATC closely. If the price they can charge is above ATC, each unit makes a profit.
- ATC
- TC / output = AFC + AVC.
- AFC
- FC / output; always falls as output rises.
- AVC
- VC / output; usually falls then rises.
| Output | FC | VC | TC |
|---|---|---|---|
| 1 | 100 | 40 | 140 |
| 2 | 100 | 70 | 170 |
| 3 | 100 | 90 | 190 |
| 4 | 100 | 120 | 220 |
| 5 | 100 | 170 | 270 |
| Output | ATC | AFC | AVC |
|---|---|---|---|
| 1 | 140 | 100 | 40 |
| 2 | 85 | 50 | 35 |
| 3 | 63.33 | 33.33 | 30 |
| 4 | 55 | 25 | 30 |
| 5 | 54 | 20 | 34 |
Worked example: Working through a cost table
A small workshop has fixed costs of $100 a day. Use the table below.
- At 2 units: TC = 100 + 70 = $170, so ATC = 170 / 2 = $85.
- At 4 units: TC = 100 + 120 = $220, so ATC = 220 / 4 = $55.
- AFC falls from $50 at 2 units to $25 at 4 units, as fixed cost is spread.
- AVC at 4 units = 120 / 4 = $30.
Watch out for this
Average total cost is total cost divided by the price.
ATC is total cost divided by output, the number of units made. Price is a revenue measure, not a cost.
Check your understanding
A firm has fixed costs of $600 and variable costs of $900 when it makes 300 units. What is its ATC?
- $5
- $3
- $1,500