Average Total Cost Formula (Table of Contents)
- Average Total Cost Formula
- Examples of Average Total Cost Formula (With Excel Template)
- Average Total Cost Formula Calculator
Average Total Cost Formula
Average total cost is basically a cost measure in per unit of output produced by the firm. Sometimes, it is also per unit total cost because of the reason that it is calculated by diving the total cost of production by the number of units produced.
Here’s the Average Total Cost Formula –
Here Total cost includes all the costs which are required to produce the goods. It includes both Fixed cost (one time cost which is required to produce the goods but does not change with the output) and Variable cost (per unit cost to produce the goods which change as per the output)
Total cost = Fixed cost + Total variable cost
Average total cost, during the initial stages of production, will be higher and will go down as we increase the number of units produced. This due to the fact that when a business will start its production, they have to incur certain fixed cost like buying machinery, equipment etc. This cost is not related to how many unit businesses is going to produce. So as the unit produced keeps on increasing, per unit fixed cost will drop so as the average total cost.
Examples of Average Total Cost Formula (With Excel Template)
Let’s take an example to understand the calculation of Average Total Cost formula in a better manner.
Average Total Cost Formula – Example #1
Suppose there is an FMCG company which is producing candy for kids. Fixed Cost which they have invested in equipment etc. is $10,000. Variable cost per pack of candy is $12. The company is producing 1000 on an average.
Total Variable Cost is calculated using the formula given below
Total Variable Cost = Variable Cost per Pack * Number of Packs
- Total Variable Cost = $12 * 1000
- Total Variable Cost = $12000
Total Cost is calculated using the formula given below
Total Cost = Fixed cost + Total Variable Cost
- Total Cost = $10000 + $12000
- Total Cost = $22000
Average Total Cost is calculated using the formula given below
Average Total Cost = Total Cost of Production / Number of Units Produced
- Average Total Cost = $22000 / 1000
- Average Total Cost = $22
Average Total Cost Formula – Example #2
Company ABC Inc.is working in manufacturing/assembling of Cars. So for them, costs like Steel, glass screens, number of tires, car seats, engines etc. all are variable costs because all of these costs will vary as per the number of cars the company is producing. But costs like plant, assembly line, equipment, R&D etc. all are fixed cost since these costs does not have direct linkage with the unit produced.
Total fixed cost is calculated as:
Total fixed cost = $1,045,000
Total variable cost per car is calculated as:
Total variable cost per car = $1450
Total variable cost is calculated as:
Total variable cost = $1,450,000
Total Cost is calculated using the formula given below
Total Cost = Fixed cost + Total Variable Cost
- Total Cost = $1,045,000 + $1,450,000
- Total Cost = $2,495,000
Average Total Cost is calculated using the formula given below
Average Total Cost = Total Cost of Production / Number of Units Produced
- Average Total Cost = $2,495,000 / 1000
- Average Total Cost = $2495
Now, if we increase the number of cars, fixed cost will not change and only variation will happen in the variable cost
Total variable cost is calculated as:
Total variable cost = $2,900,000
Total Cost is calculated using the formula given below
Total Cost = Fixed cost + Total Variable Cost
- Total Cost = $1,045,000 + $2,900,000
- Total Cost = $3,945,000
Average Total Cost is calculated using the formula given below
Average Total Cost = Total Cost of Production / Number of Units Produced
Average Total Cost = $3,945,000 / 2000
Average Total Cost= $1973
So if you see here, as we increase the number of cars, the average total cost per car dropped. This is because that fixed cost is now spread over 2000 units and per unit fixed cost is lower as compared to an earlier scenario.
Average Total Cost curve:
For small quantity of output, as explained earlier, the total cost is higher. But as we keep on increasing the quantity, average costs start to decline. But now the catch is that this decline will not continue forever and after a certain level, the average cost starts to increase. This is because of the concept of diminishing marginal return which states that after some point, adding an additional factor of production will result in a smaller increase in output. This is the reason that Average total cost curve is U Shaped curve. I will elaborate that will the help of an example:
Average Total Cost Formula – Example #3
Relevance and Uses of Average Total Cost Formula
As explained above, the average total cost will give us an idea of what is the per unit cost a company will incur to produce stipulated number of units of goods. Also, we have seen that as the production increases, the total cost will drop because of spreading of the same fixed cost over more units now. But due to diminishing marginal return, the variable cost after a particular point will start increasing. This is because of a decrease in margin productivity and a return of the additional resource we are adding.
The company can use this concept of average total cost to analyze various aspects of their production and can utilize their resources in more efficient manner. Few relevant uses of average total cost formula are :
- Companies can see what is the optimal point of production for them and what is the level of production which minimize their cost
- If they need additional fixed cost due to increase in demand etc., companies can analyze what should be production quantity, so that the fixed cost addition will not shoot up their average total cost.
- Companies can use this concept to plan and increase the capacity of production so that they are utilizing their resource well
Average Total Cost Formula Calculator
You can use the following Average Total Cost Calculator.
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