Average Variable Cost
What is Average Variable Cost?
Average Variable Cost is the variable cost per unit of output produced.
It is calculated by dividing total variable cost by quantity of output. Average variable cost typically declines at first due to increasing efficiency, then rises due to diminishing marginal returns.
Average Variable Cost: a worked example
Pouring 40 candles uses $360 of wax, wicks, jars, and hourly labor, which works out to 360 ÷ 40 = $9 per candle. Raising output to 80 candles brings the variable bill to $560, so AVC drops to 560 ÷ 80 = $7. Pushing to 120 candles forces overtime and the variable bill hits $1,080, lifting AVC back to 1,080 ÷ 120 = $9. Minimum AVC is $7 at 80 candles, and that is the shutdown price. Sell candles for $6 and an 80 candle batch earns 6 × 80 = $480 against $560 of variable cost, adding $80 of loss on top of the fixed rent the maker owes either way.
The mistake students make with average variable cost
Students apply the shutdown test against average total cost and close the firm the moment price falls below ATC. Losing money feels like a reason to stop. In the short run the fixed costs are owed either way, so the comparison that matters is price against AVC. A firm with ATC of $12 and AVC of $8 selling at $10 loses money on paper yet should keep producing, because each unit covers its $8 of variable cost and hands over $2 toward the fixed bill. Shut down only when price drops under minimum AVC.
Average Variable Cost questions
What is the shutdown rule in terms of average variable cost?
A firm should stop producing in the short run when price falls below minimum average variable cost. At that point revenue does not even cover the variable inputs, so every unit produced adds to the loss beyond the fixed costs already owed. When price sits above minimum AVC but below ATC, staying open is the better of two bad options, because the surplus over variable cost chips away at fixed costs.
Why is average variable cost U shaped?
Average variable cost traces productivity in reverse. Early hires specialize and each added worker produces more than the last, so variable cost per unit drops. Once diminishing marginal returns set in, each added worker produces less, and the same wage now buys fewer units, pushing cost per unit back up. Minimum AVC lines up with maximum average product, which is why the two curves are often taught together.
Does the gap between ATC and AVC ever close?
The gap narrows forever but never disappears, because it equals average fixed cost. With fixed costs of $500, the gap is $5 at 100 units, $2.50 at 200 units, and $1 at 500 units. Drawing the AVC curve merging into ATC is a common graphing error on free response questions, since positive fixed costs keep the two curves apart at every output level.
Formula / Example
This is the live Production Costs sandbox. Drag the curves, or open the full version.
Related terms
Common comparisons
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