Average Costs

Introduction

The price of goods and services on a given day is known as the average cost. While we have several items to buy and sell at almost the same price, by calculating the mean we can find the average cost. It assists shopkeepers in the purchase and sale of products. The average cost is calculated by dividing the total cost of all products by the total number of goods. The mean of data is the average of all the data in a specific set.

What is the Average Cost?

It’s also referred to as the average total cost or the unit cost. It may also be possible to break down the total cost of production into fixed costs and variable costs. Because the total fixed cost component rarely changes, the change in average cost is primarily due to the change in total variable cost. If the cost is over the threshold, increase the selling price and negotiate the variable cost component, since failing to do so would result in the loss of revenue.

How to Calculate Average Cost?

Following these five steps will allow us to compute it:

Step one: Determine the fixed cost of production for the specified time, including salaries, depreciation and amortisation, lease rental, marketing and advertising costs, and so on. These cost heads are constant regardless of production volume.

Step two: Determine the variable cost of production incurred over the specified period, which includes raw material costs, salaries, and electricity bills, among other things. These cost heads are determined mainly by the amount of manufacturing.

Step three: Next, add up the fixed (step 1) and variable (step 2) production costs to get the overall cost of production (step 2).

Total Cost of Production = Fixed Cost of Production + Variable Cost of Production

Step four: Calculate the number of units generated within the specified period.

Step five: Finally, as shown below, divide the total cost of production (step 3) by the number of units produced (step 4) to get the average cost of production.

Average Cost Formula = Total Cost of Production / Number of Units Produced.

Average Fixed Cost

Average Fixed Cost refers to the company’s production expenses that are fixed at goods generated (per unit). Because the fixed cost remains constant while the quantity of outputs rises, this average cost decreases as the quantity of output produced increases.

Rent, salaries paid to permanent staff, mortgage payments on plant and machinery are examples of fixed costs. This cost remains constant, but when the total number of units produced increases, the average fixed cost of the company lowers since the same amount of fixed expenses incurred by a company is distributed out over a more significant number of units of output. It differs from average variable cost, which remains constant regardless of changes in the number of commodities produced by the company.

Average Fixed Cost formula = Total Fixed Cost / Output

It could also be computed by the average variable cost of the company being deducted from the average total cost because the total cost of the firm could be fixed and variable, so if the variable cost is subtracted from the total cost, the consequence is the fixed cost. Mathematically:

AFC formula = Average Total Cost (ATC) – Average Variable Cost (AVC)

Average Variable Cost

The variable cost per unit of products or services is the average variable cost. The variable cost is determined by dividing the total variable cost for the period by the number of units produced.

The formula is as follows:

Average Variable Cost (AVC)= VC/Q

Where,

VC is the Variable Cost,

Q is the quantity of output produced

You can also use the average total and average fixed costs to compute the AVC. It is written as follows:

AVC = ATC – AFC

Where,

ATC is Average Total Cost

AFC is Average Fixed Cost

Conclusion

Understanding the significance of average cost will also assist you in comprehending how it operates over time. Costs, for example, vary according to seasonal demand and production efficiency. When you determine the average cost, you’re essentially normalising or levelling out the entire manufacturing cost per unit. The average cost per unit of production (AC) is also known as the average total cost (ATC). Divide the total cost (TC) by the quantity produced by the company to find it (Q). The average cost is a significant component in shaping market supply and demand. So this was all about the average cost. For better understanding, you can go through this topic.