Average Cost
Average cost refers to the total cost of production per unit of output. It is calculated by dividing the total cost by the quantity of output produced. This metric is important for businesses to determine the cost efficiency of their production processes and to make pricing decisions.
8 Key excerpts on "Average Cost"
eBook - ePub- Enrico Colombatto(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...It provides an effective synthesis of the outcomes generated by the producers’ choices aiming at efficiency broadly understood, and it is the benchmark with respect to which competitiveness is assessed, since the nearer the firm is to its total-cost curve, the better its short-run position in the industry and its chances to make profits or contain losses. In this and the following sections, we shall go one step further and show that closer inspection of the firm's cost structure also provides useful insights about how producers determine the profit-maximising level of output, about when it pays to stop producing and wait for better times, and about when it is advisable to liquidate the company and quit the industry altogether. Here, however, economics usually departs from total-cost curves, preferring instead to focus on ‘Average Costs’ and ‘marginal costs’. To these categories we now turn our attention. Average Cost is total cost divided by the quantity of output. In other words, Average Cost is the cost per unit of output. Of course, since total costs are the sum of fixed and variable costs, Average Cost is the sum of average fixed cost and average variable cost. This is illustrated in Figure 4.2, in which the dashed lines describe average fixed and variable costs, and the continuous lines are average (total) cost. Note that the average fixed-cost curve represented in the figure slopes downward until X 1, the threshold beyond which a new wave of fixed costs needs to be incurred – for example, to increase production capacity. Until that point (X 1), an increase in output means that a given amount of (fixed) initial costs is spread over larger and larger amounts of goods and services and that, therefore, the burden of such costs per each unit of output becomes lighter and lighter. Figure 4.2 Average Cost curves By contrast, average variable cost curves are usually U-shaped. Two things account for this...
eBook - ePub- Tom Craig, David Campbell(Authors)
- 2012(Publication Date)
- Routledge(Publisher)
...It is thus considered as a short-run fixed cost. In the long-run, however, the fixed costs can be reduced by giving up use of the property (or selling a machine, building, etc.). What was a short-run fixed cost can thus become a long-run variable cost. Most calculations in micro-economics are based on the short-run basis. When we enter a discussion of economics in the longer run, it can get very complicated as all fixed costs can become variable eventually (i.e. in the very long-run). Average and Marginal Costs Economists, in analysing the costs of a business use the terms average and marginal costs to get a better understanding of how costs are incurred by a business. Let us first define the terms. The Average Cost of a business describes is the cost, on average, attributable to each unit of output (e.g. each can of beer, washing machine, car, etc.). Whilst businesses may know some costs, (e.g. the material cost) of each item it makes (but in practice even this is often unknown), it can allocate fixed costs to an item by performing a simple calculation. We find the Average Cost by dividing the total cost by the output in units or quantity. average cost = total cost quantity or A C = T C Q The marginal cost is the total cost incurred by the business for each extra unit of output it produces. Initially, we would expect the marginal cost to fall as output (quantity) increases. This is because each extra unit produced ‘dilutes’ the fixed costs by that little bit more and although the variable cost attributable to each unit may remain relatively constant, the total cost per unit incurred is likely to fall. When output rises past a certain level, however, the marginal cost usually starts to rise. At the point at which it starts to increase, the business is beginning to increase its total costs faster that it can recover them through simply producing more units...
eBook - ePub- Andrew Barkley, Paul W. Barkley(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
...Average variable costs are variable costs divided by the level of output. Average total costs are total costs divided by the level of output. Marginal cost is the additional cost of producing one more unit of output. A typical total cost curve increases at a decreasing rate and then increases at an increasing rate as diminishing marginal returns set in. If MC > AC, the Average Costs are increasing; if MC > AC, then Average Costs are decreasing. A firm’s cost curves reflect the firm’s productivity: an increase in productivity is identical to a decrease in costs. A constant cost firm faces constant production costs for all units of output produced. A decreasing cost firm has per-unit costs that decrease as output increases. An increasing cost firm has increasing per-unit costs as output increases. A firm with “typical” cost curves is one whose Average Costs decrease then increase. 3.8 Chapter 3 glossary Accounting Costs —Explicit costs of production; costs for which payments are required. Accounting Profits [π A ] —Total revenue minus explicit costs. π A = TR – TC A (see Economic Profits). Average Costs [AC] —Total costs per unit of output. AC = TC/Y. Note that Average Costs (AC) are identical to average total costs (ATC). Average Fixed Costs [AFC] —The Average Cost of the fixed costs per unit of output. AFC = TFC / Y. Average Total Costs [ATC] —The average total cost per unit of output: ATC = TC / Y. Note that Average Costs (AC) are identical to average total costs (ATC). Average Variable Costs [AVC] —The Average Cost of the variable costs per unit of output: AVC = TVC / Y. Costs of Production —The payments that a firm must make to purchase inputs (resources, factors). Economic Profits [π E ] —Total revenue minus both explicit and opportunity costs...
eBook - ePub- Bonnie Nguyen, Andrew Wait(Authors)
- 2015(Publication Date)
- Routledge(Publisher)
...The long-run Average Cost curve is the broken black curve that runs beneath them. As more short-run Average Cost curves are drawn in, the long-run Average Cost curve will become smoother The term economies of scale refers to cost advantages that a firm obtains from increasing its output. Specifically, if long-run Average Costs are decreasing with output, this is called economies of scale. On the other hand, if long-run Average Costs are increasing with output, this is known as diseconomies of scale. If long-run Average Costs are constant as output expands, by definition there are constant Average Costs. 4 These three cases are illustrated in Figure 7.5. Figure 7.5 When the LRAC curve is downward-sloping, the firm is experiencing economies of scale; when the LRAC curve is upward-sloping, there are diseconomies of scale. When the LRAC curve is flat, there are constant Average Costs 7.5.3 A final note Even though we have allowed all inputs to be variable in the long run, we have also implicitly assumed that several things remain constant. First, we have assumed that input prices are fixed. Second, we have assumed that there have been no changes in the state of technology that would affect a firm’s ability to produce output. Of course, in the real world these changes are typical and important, but we have abstracted from such changes in order to better understand a firm’s costs in both the long run and the short run. 7.6 Total revenue, total cost and economic profit In order to derive a firm’s economic profit, we will need to define its total revenue and total cost. Total revenue (TR) is the amount a firm receives for the sale of its output. This will be the price at which the firm sells each unit, multiplied by the quantity of units sold: 7.3 T R = P × Q Total costs (TC) refers to the economic costs that a firm incurs for producing output, as we have discussed in this chapter. When we refer to economic costs, we include all opportunity costs...
eBook - ePubContemporary Economics
An Applications Approach
- Robert Carbaugh(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...Economies of scale and diseconomies of scale account for the U-shaped appearance of this cost curve. In discussing the general shapes of a firm’s cost curves in the short and long run, we assume that technology, resource prices, and taxes remain constant as the firm changes its level of output. Changes in any of these factors will cause a firm’s cost curves to shift upward or downward. Economists define the total costs of production as the sum of explicit costs and implicit costs. According to accounting principles, profit equals total revenue minus explicit costs. Besides caring about explicit costs, economists are interested in a firm’s implicit costs. Economic profit thus equals total revenue minus the sum of explicit costs and implicit costs. A firm that makes zero economic profit is said to earn a normal profit. It represents the minimum profit necessary to keep a firm in operation. In other words, the firm earns just enough revenue to cover its explicit costs and implicit costs. Key Terms and Concepts short run (77) fixed input (77) variable inputs (77) long run (77) production (78) production function (78) total product (79) marginal product (79) law of diminishing marginal returns (79) increasing marginal returns (79) diminishing marginal returns (79) total fixed cost (82) total variable cost (83) total cost (84) average fixed cost (84) average variable cost (84) average total cost (84) marginal cost (86) long-run average total cost curve (87) economies of scale (87) diseconomies of scale (90) constant returns to scale (90) explicit cost (93) implicit cost (93) profit (94) losses (94) accounting profit (94) economic profit (94) normal profit (94) Study Questions and Problems Table 4.6 Productivity Data Quantity of Labor Total Product Marginal. Product 0 0 1 20 2 45 3 65 4 80 5 90 As the manager of a restaurant, you estimate the total product of labor used to cook meals, as shown in Table 4.6...
eBook - ePub- J. Bridge, J. C. Dodds(Authors)
- 2018(Publication Date)
- Routledge(Publisher)
...How, for example, can the product analyst determine the desirability of an opportunity unless he has a cost figure with which to compare his market oriented price? First of all let us repeat that the economist's concern with marginal cost does not mean that variable costs are the only elements that he ever considers. We must dispel the myth that the economist advocates accepting any opportunity whose selling price covers variable costs. The misunderstanding arises because many businessmen and even some accountants, who should know better, remember that in their elementary course of economic theory firms were supposed to produce at that output where marginal cost equals price. This pertains to the theory of perfect competition and it can be proved that such a rule gives the profit maximising output. However, marginal cost is not to be confused with unit variable cost. Economists brought up on the law of diminishing returns believe that marginal cost rises steeply after a certain point so that it exceeds eventually both average variable cost and average total cost. Without repeating the cost curve controversy here, the economist certainly does not argue that pricing to cover short run variable costs is always adequate. In fact the only situation where the decision to produce rests on a simple consideration of variable costs against sales revenue is when there is ample spare capacity. As we have stressed throughout this book, there are two stages to the economist's approach. The determination of avoidable costs (e.g. variable costs in the short run – see Chapter 4, Section 4-8) and the comparison of these with incremental revenue is only the first of these stages. The second is to assess the cost of using resources the company already owns...
eBook - ePub- Rob Dransfield, Rob Dransfield(Authors)
- 2013(Publication Date)
- Routledge(Publisher)
...However, a similar approach could be used for a large global company such as BIC operating with huge economies of scale. Using the figures shown in Figure 4.2 the break-even output for each BIC pen would be £10 million/£0.20 = 50 million. Figure 4.2 The contribution of each pen to paying off fixed costs 4.3 The Average Cost of production Average Cost It is important to be able to calculate the Average Cost of producing given quantities of output. Key Term Average Cost – shows us the Average Cost of producing or selling units of a product. Average Cost is normally illustrated by a U-shaped curve. This shows that the Average Cost of producing a small number of units is high. The Average Cost will then fall as output increases. Common sense provides an explanation for this. Production involves combining factors of production. When only a small quantity of factors of production are combined they are not combined together very effectively. For example, a large factory machine may work most efficiently with five or six operatives. With fewer operatives it would be run less efficiently. Output per head from operating the machine might therefore change in the way illustrated in Table 4.2. Table 4.2 Output per head per hour with different numbers of operatives Number of operatives per hour Output per head 1 20 2 22 3 25 4 30 5 35 6 30 7 27 You can see from Table 4.2 that productive efficiency increases up to the point at which five employees are working with the machine and then it starts to fall. This point can also be illustrated with reference to another economic concept –marginal output. In economics the marginal unit is the extra unit of something that you want to measure. In this case we can measure marginal output per head per hour. The first worker was able to produce 20 units per hour. An additional (marginal) worker was able to increase the output to 22 units per head per hour – a marginal increase of 2 units per head...
eBook - ePubIntroduction to Air Transport Economics
From Theory to Applications
- Bijan Vasigh, Ken Fleming, Thomas Tacker(Authors)
- 2018(Publication Date)
- Routledge(Publisher)
...So in this case, total economic costs = $2,000,000 + $200,000 = $2,200,000 rather than the $2,000,000 of explicit accounting costs. Components of cost Proper application of cost requires a strong understanding of the relationship between cost and the level of production. Cost functions specify the technical relationship between the level of production and the production cost. Production costs can be subdivided as total, fixed, or variable. Fixed costs, variable costs, and total cost While costs categorized by time are important in accounting, the most common and practical method of classifying costs in economics is by their relation to output. In the short run, total cost (TC) consists of two categories: total fixed costs (FC) and total variable costs (VC). Fixed cost (FC) Costs that remain fixed in the short run and do not change as the level of output changes are called FCs. There are massive fixed costs associated with running an airline, an aircraft manufacturer, an airport, or an engine manufacturer. All of these aviation-related industries require specialized equipment and/or labor that are essentially fixed costs. Variable costs (VC) Costs that directly vary with changes in production are termed variable costs. For example, if you fly an aircraft 10 hours a day, your fuel cost is obviously higher than if you do not fly; if a company decides to shut down its plant for a month during summer, the labor costs will drop to zero. Variable costs may include wages, utilities, and materials used in production. They also may increase at a constant rate, an increasing rate, or a decreasing rate in proportion to the labor and capital used in production. Total cost (TC) In economics, total cost describes the total economic cost of production. When fixed costs and variable costs are added together, the result is total cost. In simple terms, As pointed out earlier, the time frame is important when categorizing costs based on their relation to output...
