Average Total Cost Formula

by Yuvi K - October 26, 2023

If you’re running a business, understanding and calculating the average total cost can help you manage your costs and make sure operations run more efficiently. The average total cost formula describes the average cost per unit of output after taking into account all fixed and variable costs associated with production. In this article, we’ll explore the the average total cost equation, how to calculate it, and how to use it to make better decisions.

What Is Average Total Cost?

The average total cost in economic terms, also known as the average cost or unit cost, is the sum of the total fixed costs and variable costs divided by the total number of units produced. This metric is used to determine the average total cost per unit for a given period of production.

Average Total Cost Formula

The average total cost formula is:

Average Total Cost = Total Fixed Cost + (Total Variable Cost / Number of Units)

Average total cost can also be written as the sum of average fixed cost and average variable cost.

Average Total Cost = Average Fixed Cost + Average Variable Cost

Average Total Cost Example

Let’s suppose a company produces 10,000 units with total fixed costs of $20,000 and total variable costs of $60,000. The average total cost can be calculated by dividing the total fixed costs and total variable costs by 10,000 – the total number of units:

Average Total Cost = $20,000 + ($60,000 / 10,000) = $8 per unit

How to Calculate Average Total Cost?

Average total cost can be calculated in three simple steps:

1. Calculate the sum of all fixed costs.
2. Calculate the sum of all variable costs.
3. Divide the total fixed costs and total variable costs by the number of units produced.

Interpreting the Result

Calculating average total cost serves two primary purposes. The first is to show how a company’s costs are distributed over different number of units. The second is to show how a company’s costs break down into fixed and variable costs.

The average total cost can also assist in projecting future production and cost levels, as well as help companies compare current costs with industry standards in order to adjust operations and maximize profits.

Average Total Cost in Business

An understanding of the average total cost helps businesses better understand their operations, costs and profitability. Knowing this information can guide decisions such as whether it’s more profitable to add new equipment or increase manpower in order to increase production.

The average total cost is also a useful tool for examining the competitive landscape. By comparing your average total cost with industry standards, businesses can get a better understanding of how they compare to their competitors in terms of costs and efficiency.

Finally, the average total cost can help businesses make better pricing decisions. When setting prices, businesses can use average total cost to determine how to set the right price in order to make a reasonable profit.

Conclusion

Average total cost is a useful metric for measuring production costs, interpreting the competitive landscape and making better pricing decisions. By understanding how to calculate and use average total cost, businesses can make better decisions and achieve greater levels of profitability.