Average cost

In economics, average cost and/or unit cost is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q). Average costs may be dependent on the time period considered (increasing production may be expensive or impossible in the short term, for example). Average costs affect the supply curve and are a fundamental component of supply and demand.

Average cost is distinct from the price, and depends on the interaction with demand through elasticity of demand and an average cost due to marginal cost pricing.

Short-run average cost will vary in relation to the quantity produced unless fixed costs are zero and variable costs constant. A cost curve can be plotted, with cost on the y-axis and quantity on the x-axis. Marginal costs are often shown on these graphs, with marginal cost representing the cost of the last unit produced at each point; marginal costs are the slope of the cost curve or the first derivative of total or variable costs.

A typical average cost curve will have a U-shape, because fixed costs are all incurred before any production takes place and marginal costs are typically increasing, because of diminishing marginal productivity. In this "typical" case, for low levels of production marginal costs are below average costs, so average costs are decreasing as quantity increases. An increasing marginal cost curve will intersect a U-shaped average cost curve at its minimum, after which point the average cost curve begins to slope upward. For further increases in production beyond this minimum, marginal cost is above average costs, so average costs are increasing as quantity increases. An example of this typical case would be a factory designed to produce a specific quantity of widgets per period: below a certain production level, average cost is higher due to under-utilized equipment, while above that level, production bottlenecks increase the average cost.

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