average cost

(noun)

In economics, average cost or unit cost is equal to total cost divided by the number of goods produced.

Related Terms

Examples of average cost in the following topics:

  • Average and Marginal Cost

    • The average cost is the total cost divided by the number of goods produced.
    • It is also equal to the sum of average variable costs and average fixed costs.
    • When the average cost declines, the marginal cost is less than the average cost.
    • When the average cost increases, the marginal cost is greater than the average cost.
    • When the average cost stays the same (is at a minimum or maximum), the marginal cost equals the average cost.

  • Average Cost Method

    • Under the Average Cost Method, It is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period.
    • Under the average cost method, it is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period.
    • There are two commonly used average cost methods: Simple Weighted Average Cost method and Moving-Average Cost method.
    • Moving-Average (Unit) Cost is a method of calculating Ending Inventory cost.
    • The Weighted-Average Method of inventory costing is a means of costing ending inventory using a weighted-average unit cost.

  • Inventory Techniques

    • FIFO, LIFO, and average cost methods are accounting techniques used in managing inventory.
    • Average cost method is quite straightforward.
    • There are two commonly used average cost methods: Simple weighted average cost method and moving average cost method.
    • This gives a Weighted Average Cost per Unit.
    • Finally, this amount is multiplied by Weighted Average Cost per Unit to give an estimate of ending inventory cost.

  • Weighted Average Cost of Capital

    • The WACC is the cost of capital taking into account the weights of each component of a company's capital structure.
    • The weighted average cost of capital (WACC) is the rate a company is expected to pay, on average, to its security holders.
    • Stated differently, the return on capital of a new project must be greater than the weighted average cost of capital.
    • In order to calculate WACC, a few inputs must be known, namely, the cost of debt, the cost of equity, and the company's marginal tax rate.
    • The costs of debt and equity incorporate the individual costs of each form of debt and equity, such as common stock, preferred stock, retained earnings, and different types of bonds.

  • The Law of Diminishing Returns

    • Average total cost is interpreted as the the cost of a typical unit of production.
    • Average total cost can also be graphed with quantity of output on the x axis and average cost on the y-axis.
    • What will this average total cost curve look like?
    • As long as the marginal cost of production is lower than the average total cost of production, the average cost is decreasing.
    • Average cost begins to increase where it intersects the marginal cost curve.

  • Economic Costs

    • Average cost (AC): total costs divided by output (AC = TFC/q + TVC/q).
    • Average fixed cost (AFC): the fixed costs divided by output (AFC = TFC/q).
    • Average variable cost (AVC): variable costs divided by output (AVC = TVC/q).
    • The average variable cost curve is normally U-shaped.
    • It lies below the average cost curve, starting to the right of the y axis.

  • Production Outputs

    • Average total cost is the all expenses incurred to produce the product, including fixed costs and opportunity costs, divided by the number of the units of the good produced.
    • Normal Profit: The average total cost equals the price at the profit-maximizing output.
    • Loss-minimizing condition: The firm's product price is between the average total cost and the average variable cost.
    • Shutdown: The price is below average variable cost at the profit-maximizing output.
    • It is not produced based on average total cost (ATC).

  • Cost-Based Pricing

    • Cost-based pricing is the act of pricing based on what it costs a company to make a product.
    • Price = (1+ Percent Markup)(Unit Variable Cost + Average FixedCost) .
    • Imagine a firm whose average costs de­crease with sales.
    • However, pricing at average cost for small-scale capacity means that the firm may never discover this.
    • Cost-based pricing is misplaced in industries where there are high fixed costs and near-zero marginal costs.

  • Costs and Production in the Short-Run

    • Average Fixed Cost (AFC) is the FC divided by the output or TP, Q, (remember Q=TP).
    • AFC is fixed cost per Q.
    • Average Variable Cost (AVC) is the VC divided by the output, AVC = VC/Q.
    • It is the variable cost per Q.
    • Average Total Cost (AC or ATC) is the total cost per unit of output.

  • Cost of capital

    • The cost of capital refers to the cost of the money used to pay for the capital.
    • Moreover, if a project contains a similar risk to a company's average business activities, then it is reasonable to use the company's average cost of capital as a basis for evaluating the success of investment .
    • In order to determine a company's cost of capital, the cost of debt and the cost of equity must be calculated.
    • One way of combining the cost of debt and equity to generate a single cost of capital number is through the weighted-average cost of capital (WACC).
    • The cost of capital is the cost of the money used to finance the plant.