Average fixed cost (i.e., AFC) is defined as the sum of all fixed costs of production divided by the quantity of output. That means AFC describes the share of all fixed costs that can be attributed to each unit. This is important for firms when it comes to production decisions because it helps them to optimize production and thereby maximize profits. Thus, if you are currently enrolled in an economics class, you will probably have to calculate average fixed costs at some point. Fortunately, however, that’s not rocket science. We can calculate average fixed cost by following a simple three-step process: (1) Find quantity, (2) find fixed cost, and (3) divide fixed cost by quantity.
1) Find Quantity (Q)
First of all, we have to find the total quantity of output (Q). Q describes how many units of a good or service a firm produces to sell on the market. In most exams or quizzes, Q will be provided as part of the question, so you won’t have to calculate anything. However, in some cases, you may have to calculate Q yourself by carrying out profit maximization first. For the sake of simplicity, we’ll assume Q is provided for now.
To give an example, assume a friend of yours owns a fast food restaurant. Let’s call it Quick Burger. Last month, Quick Burger sold exactly 20,000 burgers. That means the total quantity of output (Q) is 20,000. Pretty simple, right?
Hint: Please note that we use a capital Q in this article to describe total quantity, which is the most common way to do it. However, there may be some cases where quantity appears as a lowercase q. Don’t let that confuse you. This usually just means that the authors want to emphasize the fact that the firm is really small.
2) Find Fixed Cost (FC)
Next, we have to find fixed cost (FC). Fixed cost includes all costs and expenses that don’t change as the level of output increases or decreases. Thus, they have to be paid regardless of the level of production. Some common examples of fixed costs include insurance, rent, utilities expense, and wages. Most of these costs are incurred periodically and irrespective of the current level of output. That means, even if the firm produces zero units a good or service, it still has to pay rent and insurance and so on (at least in the short run).
Going back to our example, we can assume that your friend has to pay rent to run Quick Burger. Assume her monthly rent is USD 4,000. She’ll have to pay this amount regardless of the number of burgers she sells. In addition to that, we’ll assume she has to pay USD 1,000 for insurance and USD 5,000 in salaries each month. That means, her total fixed costs add up to USD 10,000 (i.e. 4,000 + 1,000 + 5,000).
3) Divide Fixed Cost by Quantity
Finally, we can calculate the average fixed cost by dividing total fixed cost by total quantity (i.e., AFC = FC/Q). This last step is required because we are trying to find the average fixed cost, i.e., the fixed cost per unit. Please note that according to the formula above, AFC always decreases as the level of output increases (and vice versa). That’s one of the reasons why many firms try to expand their production because it allows them to reduce their per-unit costs and profit from economies of scale.
To illustrate this, let’s calculate AFC for Quick Burger. So far, we know that Q = 20,000 and FC = USD 10,000. If we plug these values into the formula above we find that AFC = USD 0.50 (i.e. 10,000 / 20,000). Meanwhile, if your friend manages to expand her business and increase Q to 40,000, AFC will be USD 0.25 (i.e., 10,000 / 40,000). Similarly, if Q was 5,000, AFC would add up to USD 2.00 (10,000 / 5,000). Hence, as you can see, the average fixed cost can have a significant impact on a firm’s profitability.
In a Nutshell
Average fixed cost (i.e., AFC) is the sum of all fixed costs of production divided by the quantity of output. It describes the share of all fixed costs that can be attributed to each unit. To calculate average fixed cost, we can follow a simple three-step process: (1) Find quantity, (2) find fixed cost, and (3) divide fixed cost by quantity to obtain AFC.