Average Total Cost: Definition & Formula

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: The Importance of the Global Market and Global Trade: Role & Advantages

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
 Replay
Your next lesson will play in 10 seconds
  • 0:01 Definition of Average…
  • 1:03 Average Total Cost Formula
  • 2:38 Implications of…
  • 3:24 Lesson Summary
Add to Add to Add to

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Log in or Sign up

Timeline
Autoplay
Autoplay
Speed

Recommended Lessons and Courses for You

Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

Knowing and understanding cost structure is an important part of budgeting, production planning, and pricing decisions. In this lesson, you'll learn the definition and calculation of average total cost.

Definition of Average Total Cost

When economists, production managers, or others refer to average total cost, they are referring to the per unit cost that includes all fixed costs and all variable costs. Knowing average total cost is critical in making pricing decisions, as any price below average total cost will result in a financial loss.

Total costs are made up of fixed costs, those costs that are required for production but do not change based on output, and variable costs, those costs that increase or decrease as output increases or decreases. For example, if an organization manufactures desktop computer screens, the glass screens, plastic casings, electrical boards and wires, and screws are all variable costs. The cost of the facility they are made in and the equipment used to assemble the monitors are fixed costs. It doesn't matter if one monitor is made or 100, the cost of the facility and equipment will remain fixed.

Average Total Cost Formula

The average total cost is sometimes referred to as the per unit total cost since it is calculated by taking the total cost of production and dividing that by the number of units produced (quantity). In variable form, it looks like this:

TC / Q = ATC

Where fixed costs + variable costs (quantity) = TC

In the computer monitor example, let's set our fixed costs of the monthly lease payment for the equipment and building at $50,000. We can set our variable costs at $100. For purposes of comparing how average total cost can change based on production, let's set output (Q) at 4,000 in July and 6,000 in August.

In July, our total cost is $50,000 + $100(4,000) = $450,000. Once we have total cost, we can divide that by our quantity produced to get average total cost. For July, $450,000 / 4,000 = $112.50. In July, each monitor produced cost $112.50.

Using the same formula for August, but increasing production, results in an average total cost of $108.33. Why did the average total cost go down? While total variable costs increased as production increased, there were more units to share the fixed costs, resulting in a lower average total cost.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 160 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create An Account
Support