Average Total Cost vs Average Variable Cost
Average Total Cost and Average Variable Cost are two Production & Costs concepts in AP Economics that students often mix up. Average Total Cost is the total 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 cost by the quantity of output. Average total cost includes both average fixed and average variable costs and typically forms a U-shaped curve due to spreading fixed costs and diminishing returns.
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.
ATC vs AVC: The Gap Between the Curves Is Average Fixed Cost
| Average Total Cost | Average Variable Cost | |
|---|---|---|
| Formula | ATC = TC / Q, where total cost includes both fixed and variable cost | AVC = VC / Q, with fixed cost excluded entirely |
| Vertical distance between them | Sits above AVC by exactly AFC, a gap that shrinks toward zero as output grows and never closes | Sits below, and its height does not depend on how large the fixed cost is |
| Where the minimum sits | At a larger quantity, because falling AFC keeps pulling ATC down after AVC has turned up | At a smaller quantity, its minimum always comes first |
| Where MC crosses it | Through the minimum point of ATC | Through the minimum point of AVC, which MC reaches first |
| Which decision uses it | Whether the firm profits, and the long run stay or exit choice: compare price to minimum ATC | The short run shutdown choice: produce if price is at or above AVC |
| Lump sum fee versus per unit tax | A lump sum fee raises it by the fee divided by quantity, a per unit tax raises it by the full tax at every quantity | A lump sum fee leaves it untouched, a per unit tax raises it by the full tax |
The gap between the curves is average fixed cost, and it never closes
With a fixed cost of 48, average fixed cost is 48 divided by quantity. At an output of 6 that is 8 dollars per unit, at 12 it is 4, at 24 it is 2, and at 48 it is 1. The number keeps falling and never reaches zero, which is exactly why ATC approaches AVC from above without ever meeting it. Drawing the two curves so they touch or cross is one of the most common errors on a cost diagram, and it costs the point because it asserts that fixed cost vanished. ATC also cannot dip below AVC, since ATC equals AVC plus a positive number. Use the gap as a self-check whenever you read a cost table. If a question reports ATC of 10 and AVC of 6 at some quantity, average fixed cost there is 4, and total fixed cost is 4 times that quantity. Working backward this way is how many cost table questions are designed to be solved, since they hand you two of the three averages and expect you to recover the third.
Average variable cost bottoms out before average total cost does
Take a firm with a fixed cost of 48 and this variable cost schedule. At 4 units variable cost is 24, at 6 units it is 30, at 8 units it is 44, at 12 units it is 72, and at 16 units it is 120. The averages follow directly. AVC runs 6, then 5, then 5.5, then 6, then 7.5, so it bottoms out at 5 when output is 6. ATC runs 18, then 13, then 11.5, then 10, then 10.5, so it bottoms out at 10 when output is 12. Between an output of 6 and an output of 12, average variable cost is rising while average total cost is still falling. Nothing there is contradictory. Average fixed cost drops from 8 to 4 across that stretch, and that decline more than offsets the increase in average variable cost. The general result is that the minimum of AVC occurs at an output no greater than the minimum of ATC. If a table you build ever puts the ATC minimum first, you have made an arithmetic error somewhere in the schedule.
Which curve you compare price to depends on whether the firm can walk away yet
Both curves answer a profit question, but not the same one. Compare price to average total cost at the profit maximizing quantity and you learn whether the firm earns an economic profit, takes a loss, or breaks even. Compare price to average variable cost and you learn whether the firm should produce at all right now. Keep the schedule above, where the lowest AVC is 5 and the lowest ATC is 10. At a price of 12 the firm earns a profit, since 12 clears the minimum ATC. At a price of 8 it loses money, because 8 sits below every ATC in the schedule, and yet at its loss minimizing output of 12 units the AVC is only 6. Revenue of 96 covers variable cost of 72 and puts 24 toward the fixed 48, so the loss is 24 rather than the 48 it would swallow by closing. At a price of 4 it shuts down, not because any single unit is unprofitable but because 4 is below the lowest average variable cost in the schedule, so no output level covers even variable cost. The wording of the question tells you which comparison to run. Short run points at AVC, long run points at ATC.
Frequently asked questions
Why do ATC and AVC get closer together as output rises?
The vertical distance between ATC and AVC is average fixed cost, and average fixed cost equals total fixed cost divided by quantity. Spreading a fixed cost of 48 over 6 units gives 8 dollars per unit, over 12 units gives 4, and over 48 units gives 1. Since the numerator stays constant while the denominator grows, the gap shrinks continuously. The curves converge but never meet, because a positive fixed cost divided by any finite quantity is still positive. A diagram showing the two curves joining is claiming that fixed cost disappeared.
Can average total cost fall while average variable cost rises?
Average total cost can fall while average variable cost rises, and it happens over a real stretch of every standard cost diagram. ATC is the sum of AVC and AFC. When output increases, AFC always falls, and if it falls by more than AVC rises, ATC declines. With a fixed cost of 48, moving from 6 units to 12 units cuts AFC from 8 down to 4, a drop of 4, while AVC climbs only from 5 to 6. The net effect is that ATC falls from 13 to 10 across that range.
Should a firm compare price to ATC or to AVC when deciding to shut down?
The shutdown decision uses average variable cost. A firm produces in the short run whenever price is at or above AVC at the loss minimizing quantity, because any revenue above variable cost contributes toward a fixed cost that has to be paid either way. Average total cost answers a different question, whether the firm is profitable, and it governs long run entry and exit. A firm whose price sits between AVC and ATC operates at a loss in the short run and exits in the long run if nothing changes.
Live Production Costs graph. Drag the curves, or open the full version.
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