Concept of Average Cost

The average cost of any good or service is the cost of producing one unit of that good or service. It is calculated by dividing the total cost of production by the total number of units produced. The average total cost (ATC) is the sum of average fixed cost (AFC) and average variable cost (AVC).

The total fixed cost divided by the total number of units produced gives us the average fixed cost (AFC), and the total variable cost divided by the total number of units produced provides us the average variable cost (AVC).

These can be represented symbolically as:

Table 1.2: Units of Output, Total Fixed Cost, Total Variable Cost, Total Cost, Average Fixed Cost, Average Variable Cost, and Average Total Cost

Analysis of Average Costs from Table 1.2

In Table 1.2, we can observe that the average fixed cost (AFC) decreases continuously as the production quantity increases. This is because the total fixed cost is spread over more units of production.

The average variable cost (AVC) decreases initially as production increases but reaches its minimum at a certain level of production. After this point, the AVC increases as the number of units produced increases further. This is illustrated in the fifth column of Table 1.2, where the AVC is minimized at the production of 4 units (Rs. 13.75), and then it starts increasing again.

The average total cost (ATC), which is the sum of AFC and AVC, follows a similar pattern. It decreases as production increases until it reaches its minimum value at the fifth unit (Rs. 27), after which it increases again. This is because average total cost is influenced by both the average fixed and average variable costs. Therefore, the average total cost decreases as long as the average fixed cost is more significant than the increase in average variable cost but starts increasing after reaching its minimum point.

In conclusion, average variable cost always reaches its minimum before average total cost, with average total cost only minimizing after the production of five units. At this point, average total cost is at its lowest (Rs. 27), while average variable cost is at its minimum when the output is 4 units (Rs. 13.75).

Average Total Cost Curve

The Average Total Cost Curve shows the relationship between the quantity of goods produced and the average total cost. The distance between the X-axis and the Average Fixed Cost Curve and the Average Variable Cost Curve at each production level can be added to obtain the distance to the Average Total Cost Curve.

The Average Fixed Cost Curve shows the relationship between the quantity of goods produced and the average fixed cost, while the Average Variable Cost Curve shows the relationship between the quantity of goods produced and the average variable cost.

Based on Table 1.2, the Average Fixed Cost, Average Variable Cost, and Average Total Cost Curves are derived and shown in Graph 1.2.

Graph 1.2: Average Fixed, Average Variable, and Average Total Cost Curves

As the quantity of goods produced increases, the Average Fixed Cost Curve continuously decreases. However, the Average Variable Cost Curve initially decreases as the quantity of production increases. After reaching a certain point, it minimizes and then starts increasing as production continues.

The height of the Average Total Cost Curve at each production level is the sum of the distance between the X-axis and the Average Fixed Cost Curve and the Average Variable Cost Curve. As production increases, the Average Total Cost Curve initially decreases, reaches a minimum at a certain production level, and then begins to rise.

It is important to note that the Average Variable Cost Curve reaches its minimum before the Average Total Cost Curve. For example, at a production level of 4 units, the Average Variable Cost Curve reaches its minimum (Rs. 13.75), while the Average Total Cost Curve reaches its minimum at 5 units (Rs. 27). Both curves have a U-shape, as shown in the graph.