#cfa #cfa-level-1 #economics #reading-15-demand-and-supply-analysis-the-firm #section-3-analysis-of-revenue-costs-and-profit

Average variable cost (AVC) is derived by dividing total variable cost by quantity. For example, average variable cost at 5 units is (300 ÷ 5) or 60. Over an initial range of production, average variable cost declines and then reaches a minimum point. Thereafter, cost increases as the firm utilizes more of its production capacity. This higher cost results primarily from production constraints imposed by the fixed assets at higher volume levels. The minimum point on the AVC coincides with the lowest average variable cost. However, the minimum point on the AVC does not correspond to the least-cost quantity for average total cost. In Exhibit 13, average variable cost is minimized at 2 units, whereas average total cost is the lowest at 3 units.

Average total cost (ATC) is calculated by dividing total costs by quantity or by summing average fixed cost and average variable cost. For instance, in Exhibit 13, at 8 units ATC is 125 [calculated as (1,000 ÷ 8) or (AFC + AVC = 12.5 + 112.5)]. Average total cost is often referenced as per-unit cost and is frequently called average cost. The minimum point on the average total cost curve defines the output level that has the least cost. The cost-minimizing behavior of the firm would dictate operating at the minimum point on its ATC curve. However, the quantity that maximizes profit (such as Q3 in Exhibit 17) may not correspond to the ATC-minimum point. The minimum point on the ATC curve is consistent with maximizing profit per-unit, but it is not necessarily consistent with maximizing total profit. In Exhibit 13, the least-cost point of production is 3 units; ATC is 75, derived as [(225 ÷ 3) or (33.3 + 41.7)]. Any other production level results in a higher ATC.

Marginal cost (MC) is the change in total cost divided by the change in quantity. Marginal cost also can be calculated by taking the change in total variable cost and dividing by the change in quantity. It represents the cost of producing an additional unit. For example, at 9 units marginal cost is 300, calculated as [(1,300 – 1,000) ÷ (9 – 8)]. Marginal cost follows a J-shaped pattern whereby cost initially declines but turns higher at some point in reflection of rising costs at higher production volumes. In Exhibit 13, MC is the lowest at 2 units of output with a value of 25, derived as [(175 – 150) ÷ (2 – 1)].


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