Average Fixed and Variable Costs
A common misconception about costs is that large companies have lower costs than small companies because they have greater output. To create more output, however, a company must pay more. When considering the benefits of increasing output, companies must recognize that overhead costs will vary accordingly. This concept relates to the cost-effective idea of average fixed cost.
Average Fixed Cost
Average Variable Cost
"Average fixed costs (AFC) are the fixed costs (FC) divided by the number of units of output (Q): AFC = FC / Q" (Baye, 2010, p. 178).
Because fixed costs are not affected by output, when manufacturing additional output, the fixed costs are distributed among a larger amount of output. As a result, average fixed costs constantly lower as output increases.
Baye, M. R. (2010). Managerial economics and business strategy (7th ed.). New York, NY: McGraw-Hill/Irwin.
Average variable cost offers a degree of variable costs per item. "Average variable cost (AVC) is defined as the total variable cost (VC) divided by the number of units of output (Q): AVC= VC (Q)/Q" (Baye, 2010, p. 178).
The average variable cost decreases with less output and increases with more output. If the potential income is less than the average variable cost, it is more cost-effective for a company to stop production in the short run. The company may incur an economic loss, as it will still need to pay some variable costs and all fixed costs, but its overall savings may make this decision worthwhile.
Baye, M. R. (2010). Managerial economics and business strategy (7th ed.). New York, NY: McGraw-Hill/Irwin.
