Formula
Average Cost (AC) = Total Cost (TC) ÷ Quantity (Q)
Where:
- AC = average cost
- TC = total cost (fixed + variable costs)
- Q = quantity of output produced
Within Average Cost:
- Fixed Costs: These costs remain constant regardless of the production level, such as rent, salaries, and insurance.
- Variable Costs: These costs change with the level of output, such as raw materials and direct labor.
- Total Cost: The sum of fixed and variable costs, total cost grows as production increases, but the proportion of fixed and variable costs varies.
Understanding your results
If the result is a small number, it means each item costs a little amount to make. If it’s a big number, each item costs more to make.
How to calculate Average Cost – Step by Step
Step 1 – Find the total cost (TC). This is all the money you spent making your items.
Step 2 – Find how many items you made (Q)
Step 3 – Use the formula or the calculator to find the average total cost.
What is Average Cost (or Average Total Cost)?
Average cost is the cost, on average, to produce one unit of output. It means how much each item costs on average when you split the total cost evenly.
If a toy factory spends $100 to make 10 toys, the average cost is $10 per toy.
Marginal Cost vs. Average Cost
Marginal cost is how much it costs to make one more item (e.g., making one more cup). Average cost is the cost, per unit, spread across all units.
Average Cost: If a toy factory spends $100 to make 10 toys, the average cost is $10 per toy ($100 ÷ 10 units = $10 per unit). If it spends $121 to make 11 toys, the average cost is $11 per toy ($121 ÷ 11 units = $11 per unit).
Marginal Cost: If a toy factory spends $100 to make 10 toys, we would not know the marginal cost without more information. If the same factory spends $121 to make 11 toys, then the marginal cost of producing the 11th toy would be ($121 – $100) ÷ (11 – 10) = $21 ÷ 1 = $21. The 11th toy would cost an additional $21 to produce.
Average Cost vs. Average Fixed Cost vs. Average Variable Cost
Average fixed cost is the per unit cost, on average, of only the fixed costs of production. Fixed costs are shared across each item (e.g., administrative costs and the rental cost for the factory). It does not include variable costs such as the parts for the toys or labor used to make the toys.
Average variable cost is the per unit cost, on average, of only the variable costs of production. Variable costs include costs that change based on how many items you make (e.g., parts and labor used to make the toys). It does not include costs that do not change with the number of units produced (such as administrative costs and the rental cost for the factory)
Average cost includes all costs (fixed and variable) for each item. It is the cost, on average, to produce one unit of output.
Table
Average Cost, with a fixed cost of $100,000 and a variable cost of $10 / unit
| Units Produced | Average Total Cost |
| 1 | $100,010 |
| 10 | $10,010 |
| 100 | $1,010 |
| 1,000 | $110 |
| 5,000 | $30 |
| 10,000 | $20 |
| 50,000 | $11 |
| 100,000 | $11 |
| 500,000 | $10.20 |
| 1,000,000 | $10.10 |
FAQs
Q: How does average cost change as production scales?
A: It depends. In most cases, as production increases, average cost declines due to the spreading of fixed costs. An example would be that it costs $1,000 to rent a factory to produce toys. Whether 1 toy or 10,000 toys are produced, the firm still pays the $1,000/month in rent. If only 1 toy was produced, the average cost of that one toy would include the $1,000 in rent. If 100 toys were produced, that $1,000 in rent would be about $10 per toy. If 1,000 toys were produced, that $1,000 in rent would be shared at a cost of $1 per toy.
At higher production levels, variable costs may rise, leading to an increase in average cost. An example would be if a factory became so crowded that there was no room to work, trying to get extra output out of the factory would only slow workers down more, causing the average price per unit to go up.
Q: What happens to average cost as you make more items?
A: At first, average cost goes down because fixed costs spread out. Later, it might go up as variable costs increase. Not all firms and industries follow this pattern.
Sources and more resources
- Average Cost. (n.d.). Wikipedia. Retrieved September 23, 2024, from https://en.wikipedia.org/wiki/Average_cost
- Kacapyr, E., & Redelsheimer, J., & Musgrave, F. Barron’s AP Microeconomics / Macroeconomics (6th ed.). (2018). United States of America: Barron’s. ISBN: 978-1-4380-1065-6. Page 94.
- Pindyck, R., & Rubinfeld, D., Microeconomics (8th ed.), (2013). United States of America: Pearson. ISBN 13: 978-0-13-285712-3. Page 237.
- Nicholson, W., & Snyder, C. Microeconomic Theory – Basic Principles and Extensions (10th ed.). (2008). United States of America: Thomas South-Western. ISBN 13: 978-0-324-42162-0. Page 331.
- Greenlaw, S., & Shapiro, D., Principles of Microeconomics 2e. (2018). Houston: Rice University OpenStax. ISBN 13: 978-1-947172-35-7. Page 166.
- Marginal cost, average variable cost, and average total cost. (n.d.). Khan Academy. Retrieved September 23, 2024, from https://www.khanacademy.org/economics-finance-domain/ap-microeconomics/production-cost-and-the-perfect-competition-model-temporary/short-run-production-costs/v/marginal-cost-average-variable-cost-and-average-total-cost
- ReviewEcon.com. (2023, September 19). What do I need to know about cost curves? – ReviewEcon.com. https://www.reviewecon.com/what-do-i-need-to-know-about-cost-curves
- Jacob Clifford. (2014, October 3). Short-Run Cost Curves (Part 2)- Micro Topic 3.2 [Video]. YouTube. https://www.youtube.com/watch?v=qYKJdooEnwU