Average Variable Cost (AVC) is the cost of variable inputs for every unit produced. It is calculated by dividing total variable costs by the total quantity of output generated.
Formula: AVC = TVC / Q (Where TVC is total variable costs and Q is the quantity of output).
Key Characteristics:
- AVC initially decreases as production becomes more efficient.
- It eventually rises as production increases further due to diminishing returns.
- If output is zero, AVC is also zero because there are no variable costs.
Shape of the AVC Curve:
- The curve is U-shaped in the short run.
- The lowest point of the AVC curve happens where Marginal Cost (MC) intersects it.
Relationship with Productivity:
- When Marginal Product (MP) is higher than Average Product (AP), AVC falls.
- When Marginal Product is lower than Average Product, AVC rises.
Example:
If total variable costs are £500 for 100 units, then the AVC is £500 / 100 = £5 per unit.
Importance:
This metric helps businesses decide whether to keep operating in the short run. A firm should continue production if the price per unit is equal to or greater than the AVC.