Cost Concepts > Average Cost

• Definition: Average Cost (AC) is the cost to produce one unit of output.
• Formula:
  \[\mathrm{AC}=\frac{\mathrm{Total~Cost~(TC)}}{\mathrm{Total~Output~(Q)}}\]
• In Words: AC shows how much it costs, on average, to make each product.

Example

If a factory spends ₹800 to produce 40 units:
$\backslash [\backslash mathrm\{AC\}=\backslash frac\{800\}\{40\}\backslash ]\; =\; ₹20$ per unit.

• Definition: Cost per unit of fixed resources like rent or machines.
• Formula:
  \[\mathrm{AFC}=\frac{\mathrm{Total~Fixed~Cost~(TFC)}}{\mathrm{Output~(Q)}}\]
• Key Features:
  (i) AFC always goes down as more units are produced.
  (ii) The Curve slopes downward and never touches the axis (since fixed cost is never zero).

• Definition: Cost per unit for variable resources, such as labor or raw materials.
• Formula:
  \[\mathrm{AVC}=\frac{\mathrm{Total~Variable~Cost~(TVC)}}{\mathrm{Output~(Q)}}\]
• Key Features:
  (i) AVC usually falls first (as efficiency increases), then rises when resources become crowded (law of variable proportion).
  (ii) Shape: U-shaped curve.

• Definition: Total cost per unit, combining fixed and variable costs.
• Formula:
  \[\mathrm{ATC}=\mathrm{AFC}+\mathrm{AVC~or}\frac{TC}{Q}\]
• Key Features:
  (i) The ATC curve is also U-shaped.
  (ii) Minimum ATC happens at higher output than AVC, due to a continuing fall in AFC.

• Reason: First, cost per unit decreases as output rises (better use of resources), then increases due to inefficiency (too many variable inputs).​
• Law of Variable Proportion: At low output: increasing returns (costs fall). At high output: diminishing returns (costs rise).

Imagine a bakery: The rent stays the same, but materials and labour change with batches baked. If only a few cakes are made, each costs more. Make more cakes—cost per cake drops. But if the bakery gets too busy, mistakes and slowdowns make the average cost rise again.

• AC = TC/Q, or AC = AFC + AVC.
• AFC always falls with more output; ATC and AVC form U-shaped curves.
• Lowest ATC means most efficient production point.
• The gap between ATC and AVC shrinks as AFC gets smaller.