Some definitions will enable us to examine costs more completely. Average total cost (ATC) is total cost incurred per unit of output, and is sometimes termed unit cost, or simplified to average cost.

Average costs equal total costs divided by output (TC/q).

 

Total costs are composed of fixed and variable costs, so average total cost (ATC) equals average fixed cost (AFC) plus average variable cost (AVC). [1]  After the cost data for excavating various amounts of earth have been collected, computing each type of average cost only requires dividing each by the output level.

Average fixed cost (AFC) is the fixed cost per unit of output, or (TFC/q).

Average variable cost (AVC) is the variable cost per unit, or (TVC/q).

 

Table 3 lists these costs for your sand-and-gravel operation. Let's explore all these averages in more detail to see how they are typically related to production.

Table 3  Average Total Costs, Average Fixed Costs, Average Variable Costs, and Marginal Cost

 

(1)       Workers Per 8-hr Shift (L)	(2) Tons of Sand and Gravel Removed Daily (q)	(3)     Total Variable Cost ($) (w´L) (TVC)	(4)     Total Fixed Cost ($) (TFC)	(5)     Average Variable Cost ($) (3)/(2) (AVC)	(6)     Average Fixed Cost ($) (4)/(2) (AFC)	(7)     Average Total Cost ($) (5)+(6) (ATC)	(8)       Marginal Cost ($) (D3)/(D2) (MC)
0	0	0	$100	---	---	---	---
1	10	50	100	5.00	10.00	15.00	5.00
2	22	100	100	4.54	4.55	9.09	4.17
3	36	150	100	4.17	2.78	6.95	3.57
4	52	200	100	3.85	1.92	5.77	3.13
5	70	250	100	3.57	1.43	5.00	2.78
6	86	300	100	3.49	1.16	4.65	3.13
7	100	350	100	3.50	1.00	4.50	3.57
8	112	400	100	3.57	0.89	4.46	4.17
9	122	450	100	3.69	0.82	4.51	5.00
10	130	500	100	3.85	0.77	4.62	6.25
11	137	550	100	4.01	0.73	4.74	7.14
12	143	600	100	4.20	0.70	4.90	8.33
13	148	650	100	4.39	0.68	5.07	10.00
14	152	700	100	4.60	0.66	5.26	12.50
15	155	750	100	4.84	0.65	5.49	16.67
16	157	800	100	5.10	0.64	5.74	25.00
17	158	850	100	5.38	0.63	6.01	50.00
18	158	900	100	5.69	0.63	6.32	---
19	157	950	100	6.05	0.64	6.69	---

 

Average Fixed Costs

Just because total fixed costs do not vary with output does not make an AFC curve horizontal. AFC = TFC/q, where TFC is constant. Figure 3 shows how the AFC is related to the output of your operation, calculated in column 6 of Table 3. Total fixed costs are constant, so, as output increases, fixed costs per unit of output decline—a process that many managers describe as "spreading overhead" through high volume. [2]

Average Variable Costs

Managers can control variable costs by changing the level of output. As output grows, the AVC initially tends to fall. But eventually, diminishing marginal returns will drive up average variable costs. Seeing why this occurs requires understanding a bit about marginal cost, which is the most important cost concept of all for business decision making.

 

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