The average cost or unit cost is a term denoting the total economic cost of production per unit. It is calculated as total cost divided by the volume of production: ATC = TC / Q, where TC is total cost, Q is the volume of production.
Since the total cost is the sum of variable cost and fixed cost alternative, the average total cost can also be calculated as the sum of the average variable cost and average fixed cost.
ATC = TVC / Q + TFC / Q = AFC + AVC
where TVC is total variable cost, TFC is the total fixed cost, AVC is average variable cost and the AFC is average fixed cost.
Depending on the period during which costs are considered, there is also the short-run average total cost (SATC) and long-term average total cost or the patch.
Relationship between average total cost and marginal cost
From a mathematical point of view, the marginal cost is a derivative of the total cost. It follows that if the average total cost is decreasing with increasing production, this means that the marginal cost is less than the average total cost.
Otherwise, when the average total rises with the increase of production, this implies that the marginal cost is greater than the average total cost.
In a special case where there is no fixed cost and marginal cost is constant regardless of production volume, the average total cost equals the marginal cost of production. In situations of perfect competition, prices can be lower in comparison to average cost as a result of marginal cost pricing.
The fact that the average cost curve has its minimum at the point where the average cost is equal to marginal cost can be interpreted as follows:
– The top marginal cost decreases, then the average cost decreases rapidly because it reduces the cost required to produce additional quantities of product gradually;
– Where the marginal cost begins to rise, the fall in the average cost becomes less rapid, to zero when the marginal cost and average cost are equal;
– Beyond that point, the marginal cost still grows and therefore increasing the average cost. And the average cost is calculated taking into account the unit produced with lower marginal cost.
The average cost in actuarial
Through actuarial calculation, the average cost is the ratio between the total cost of claims (paid and reserved), the number of claims and is a component in determining the pure premium.