Blog Post 4

Hi my name is Matthias Ng, and I will be explaining the teaching Average Cost

Today, we will be learning the concept of average cost. The concept of average cost seems fairly self-explanatory. Average cost is simply the average cost of producing a unit. Average cost differs from marginal cost (recall, marginal cost is the cost of producing each additional unit), because it includes the fixed costs. Average cost will take the fixed and variable cost into consideration. First, fixed costs are costs that do not fluctuate and are expenses that a company will pay regardless of future business activity, while variable costs are costs that fluctuate based on production. Fixed cost and variable cost add up to equal the total cost. To find the average cost, you simply divide the total cost by the quantity of units.

average cost =       total cost         

                      quantity of output      

To better understand this concept, let’s go through an example.

Let’s say the Pink Panther Company has a fixed cost of $10,000 and the cost of producing each unit cost the company a further $15. How would we find the average cost of producing 100 units?

1.     First, we would find the total cost. We find this by multiplying 15 by 100. We multiple 15 by 100 because we want to know how much it costs to produce 100 units and it costs $15 dollars for every unit. We get $1,500 to produce 100 units. However, we are not done computing the total costs, next we have to add the fixed costs, which is $10,000. Therefore, the total cost of producing 100 units is $1,500 + $10,000 = $11,500

2.     The next step, is to divide the total cost by the quantity. So, $11,500 is divided by 100

$11,500/100 = $115 the average cost of producing 100 units is $115

Lastly, its important to note that in comparison to the marginal cost, the marginal cost will have a very consistent and gentle slope, while the average cost will generally have a steeper slope, as the first few units will be more expensive because it mitigates the initial costs of operating. Eventually, the average costs will taper off and the graph will become less steep. We also know that average cost is higher by just comparing it with the marginal cost and it will move towards the marginal costs as the initial costs are erased away after profits are realized.