Average Variable Cost

Published Dec 28, 2022

Definition of Average Variable Cost

Average Variable Cost (AVC) is defined as the total variable cost per unit of output. That means it is the average cost of producing one unit of output, including all the variable costs associated with it. Variable costs are those costs that vary with the level of output, such as raw materials, labor, and energy.

Example

To illustrate this, let’s look at an imaginary company that produces widgets. The company has fixed costs of USD 10,000 per month and variable costs of USD 0.40 per widget for labor and USD 0.10 per widget for raw materials. That means the total variable cost for producing 1,000 widgets is USD 500 (i.e., 0.40*1000+0.1*1000). In that case, the average variable cost for producing 1,000 widgets is USD 0.50 (i.e., 500/1000).

Why Average Variable Cost Matters

Average Variable Cost is an important concept for understanding the cost structure of a business. It helps managers to identify the most cost-effective production level and make better decisions about pricing and output. For example, if the average variable cost is USD 0.50 per widget, then the company should not sell any widgets for less than USD 0.50. Otherwise, it would lose money on each sale. Similarly, suppose the average variable cost is USD 0.50. In that case, the company should not produce more than 1,000 widgets, as that would increase the total variable cost and reduce the profitability of the business.