Average cost

Good morning students! Today we are going to learn about average cost. 

Lets assume we have a gelato company. When a company produces gelato there are two types of costs associated with its manufacturing:  fixed costs and variable costs. 

Fixed costs are what we are going to spend no matter how many buckets of gelato we are going to produce or how many employees we hire. Office space, electricity, equipment,  salary for managers are some example of fixed costs. It is important to stress that fixed cost are not related to the activity level of goods produced by the factory, in other words they are indirect costs. 

The fixed cost graph will always be a horizontal line at the point of the total expenses associated  with the production. The cost function will always start from the point of the fixed cost, unless they are zero. 

Variable costs are the full compensation for the employees wages and materials used to produces. They vary directly with the amount of buckets we make. For example: a lot more hours will be clocked & a lot of more materials such as eggs, milk, sugar etc  will be used  if we make 100 buckets of gelato compared with just 10 buckets. 

We need both fixed cost and variable cost to help us determine the average cost. To determine average cost we use the sum of fixed cost plus variable cost divided by number or gelato buckets produced. It is the formula we use to find out the unit cost at a certain production level. In other words it is the total cost to produce one unit divided by the number of good produced.  

Total Cost= Fixed Cost + Variable Cost

Average Cost= Total Cost/Quantity

We need to know the average cost in order to determine how to price our gelato buckets and how much money we need to produce them, among other reasons.

By visualizing the average total cost helps us understand more its importance. As the amount of units produced increase, the average total cost comes down for a while and then goes back up. At the lowest point of the cure is the area where the production is maximized to make the most profit for the company.

Now, lets put our new learned skills to practice.

Suppose our company’s fixed costs are $ 8,500 a month and variable costs of $15.

Please fill in the following table.

Recall

In order to find the average cost, we need to add fixed cost plus variable cost and divide it by the # of buckets produced. 

Check your work!

Let me know if you have any further questions on the subject or would like extra practice. 
Have a nice day!