Average Fixed Cost vs Average Variable Cost
Average Fixed Cost and Average Variable Cost are two Production & Costs concepts in AP Economics that students often mix up. Average Fixed Cost is the fixed cost per unit of output produced. Average Variable Cost is the variable cost per unit of output produced. Here is how they compare side by side.
It is found by dividing total fixed cost by quantity of output. Since fixed costs do not change with output, average fixed cost continuously declines as output increases.
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 Fixed Cost vs Average Variable Cost: One Only Falls, One Falls Then Rises
| Average Fixed Cost (AFC) | Average Variable Cost (AVC) | |
|---|---|---|
| What is being averaged | The fixed bill, which does not respond to output | The bill for labor and materials, which grows with output |
| Formula | AFC = FC divided by Q | AVC = VC divided by Q |
| Shape | Falls over the whole range; a rectangular hyperbola | U shaped, falling to a minimum and then rising |
| What drives the shape | Dividing a constant by a rising quantity | Productivity of the variable input, rising then diminishing |
| Relationship with marginal cost | No systematic link; MC is not read against it | Cut from below by MC exactly at the AVC minimum |
| Role in the shutdown decision | Ignored, because the bill is owed either way | Compared with price to decide whether to keep operating |
| Behavior at very large output | Approaches zero | Climbs steadily once diminishing returns bite |
Only one of these two can turn around, and productivity is the reason
Take a workshop with a fixed bill of 120 dollars and a variable bill that runs 100, 180, 240, 320, 440 and 600 dollars as output climbs from one unit to six. Divide the fixed bill by output and AFC reads 120, 60, 40, 30, 24 and 20 dollars. Divide the variable bill by the same quantities and AVC reads 100, 90, 80, 80, 88 and 100 dollars. AFC marches downward the entire way. AVC drops to its floor of 80 dollars across the third and fourth units, then climbs back to 100 dollars at six units, the same figure it started at. The reason is not arithmetic but production. Early on, extra workers specialize and each hour of labor yields more output, so variable cost per unit falls. Past some point the fixed plant is crowded, each extra worker adds less output than the one before, and the variable cost of a unit rises. AFC has no such story available to it, because its numerator cannot respond to anything. Add the two columns and you get average total cost: 220, 150, 120, 110, 112 and 120 dollars. The numbers are illustrative.
The shutdown rule uses AVC and deliberately ignores AFC
A firm deciding whether to keep the lights on this month asks one question: does the price cover average variable cost. The fixed bill is owed whether or not a single unit gets made, so it cannot change the answer. Continue the workshop above and suppose the price settles at 85 dollars. At four units the firm takes in 340 dollars and spends 320 dollars on variable inputs, leaving 20 dollars toward the 120 dollar fixed bill and a loss of 100 dollars. Shutting down produces no revenue and no variable spending, so the loss would be the full 120 dollars. Operating at a loss is the better of two bad outcomes here, and average fixed cost played no part in that comparison. Reverse the price to 70 dollars and every unit now loses money before the fixed bill is even considered, so shutting down is better. This is why the short run supply curve of a competitive firm is the marginal cost curve above the AVC minimum and not above the ATC minimum. See /glossary/fixed-costs for what belongs in the fixed bill, and /micro/perfect-competition for the shutdown and break even rules side by side.
Frequently asked questions
What is the difference between average fixed cost and average variable cost?
Average fixed cost divides costs that do not change with output by quantity, while average variable cost divides costs that do change with output by quantity. AFC falls at every level of output, and AVC falls and then rises because the productivity of the variable input eventually declines.
Why is AVC U shaped when AFC is not?
AVC follows the productivity of the variable input, which improves at first and then worsens once the fixed plant becomes crowded, so the curve falls and then rises. AFC has no productivity story behind it at all, since its numerator is a constant that simply gets split among more units.
Which one matters for the shutdown decision?
Average variable cost, because a firm that shuts down still owes its fixed costs and so cannot avoid them by stopping production. A firm keeps producing in the short run as long as price is at or above AVC, since anything above AVC contributes something toward the fixed bill.
Live Production Costs graph. Drag the curves, or open the full version.
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