You are required to calculate the average variable cost for each output level. Initially, as output increases, the average variable cost reduces. Once the low point is reached, the AVC starts rising with rising output. Hence, the average variable cost curve is a U-shaped curve.
It implies that it slopes down from left to right and then reaches the minimum point. Once it reaches the minimum mark, it starts rising again. An AVC is always a positive number. At the minimum mark, the AVC is equal to the marginal cost. Let us use an illustration to find out the behaviour of the AVC. Then it is on a declining trend up to the production of 6 units. In this article, we explain what average variable cost is, why it might be important for you and the steps to calculate it.
Average variable cost is the cost of all variable expenses involved in creating the product. Variable costs change over time and often depend on the business's production volume, like materials and labor. Fixed costs remain the same no matter how many items the company produces and may include things like facility rent. Whether a cost is variable may depend on the volume of production, and while it's a fixed cost at lower production numbers, economies of scale make it possible for those costs to vary and decrease above a certain production volume.
While the total variable costs include all variable costs for a production run, the average variable cost makes it possible to understand how much these variable costs amount to for each produced unit. Average variable cost is different from average total cost in the short run because at least one variable is fixed, while in the long run, all variables are flexible. Average variable cost is important because it can help companies to understand their financial situation and decide whether they're profitable enough to continue running.
If the average variable cost is less than the price that the company receives for selling a single item, it may decide to continue producing the item since it's paying for its own variable costs and contributing some money to the company's fixed costs.
If the average variable cost for an item is higher than the price the customer is paying, then the company is losing money by continuing to produce that item since the sale of each item is less than it costs to produce. There are two ways to calculate average variable cost, depending on what information you have. Here are the two methods:.
This method is appropriate if you have two total numbers for your production: the total variable costs and the output number, or quantity of things you made. After displaying all numbers, Adam gains an insight into the AVC. First, he notices that the AVC is relatively high for the first three inputs, and then declines until increasing again when the quantity is 10 units. This is consistent with the U-shaped pattern of the variable cost line.
Secondly, the average cost is always higher than zero. A list of the costs involved in producing cars will look very different from the costs involved in producing computer software or haircuts or fast-food meals. However, the cost structure of all firms can be broken down into some common underlying patterns. When a firm looks at its total costs of production in the short run, a useful starting point is to divide total costs into two categories: fixed costs that cannot be changed in the short run and variable costs that can be changed.
The breakdown of total costs into fixed and variable costs can provide a basis for other insights as well. The first five columns of Table 1 should look familiar — they come from the Clip Joint example we saw earlier — but there are also three new columns showing average total costs, average variable costs, and marginal costs.
These new measures analyze costs on a per-unit rather than a total basis. Watch this clip as a continuation from the video on the previous page to see how average variable cost, average fixed costs, and average total costs are calculated. Average total cost is total cost divided by the quantity of output. Average cost curves are typically U-shaped, as Figure 1 shows. Average total cost starts off relatively high, because at low levels of output total costs are dominated by the fixed cost; mathematically, the denominator is so small that average total cost is large.
Average total cost then declines, as the fixed costs are spread over an increasing quantity of output. In the average cost calculation, the rise in the numerator of total costs is relatively small compared to the rise in the denominator of quantity produced. But as output expands still further, the average cost begins to rise. At the right side of the average cost curve, total costs begin rising more rapidly as diminishing returns kick in. Figure 1. Cost Curves at the Clip Joint. The information on total costs, fixed cost, and variable cost can also be presented on a per-unit basis.
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