Average Variable Cost (AVC): Definition, Function & Equation

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  • 0:05 Average Variable Cost…
  • 1:35 AVC Function and Equation
  • 2:28 Examples
  • 3:36 Lesson Summary
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Lesson Transcript
Kallie Wells
Expert Contributor
Joseph Shinn

Joe has a PhD in Economics from Temple University and has been teaching college-level courses for 10 years.

Firms rely on several cost functions to make important production decisions. This lesson will explain the average variable cost function and what it is used for in business decisions.

Average Variable Cost Definition

The average variable cost (AVC) is the total variable cost per unit of output. This is found by dividing total variable cost (TVC) by total output (Q). Total variable cost (TVC) is all the costs that vary with output, such as materials and labor. The easiest way to determine if a cost is variable is if the output changes, the cost changes as well.

Profit-maximizing firms will use the AVC to determine at what point they should shut down production in the short run. If the price they are receiving for the good is more than the AVC given the output they are producing, then they are at least covering all variable costs and some fixed costs. Fixed costs are those costs incurred that do not vary with production; they are fixed at a certain price no matter how much is produced. The best example is rent on the space used to produce the good or provide the service. It doesn't matter how many units you produce or customers you serve, the rent will always remain the same. Therefore even if you are producing zero, as would be the case if you shut down production, you will still have to pay the fixed costs.

As long as price is above the AVC and covering some of the fixed costs, you are better off continuing production. If the price falls below the AVC, then the firm may decide to shut down production in the short run because the price is no longer covering any portion of the fixed costs or all of the variable costs. Therefore the firm would rather not incur any variable costs and just pay the fixed costs.

AVC Function and Equation

This chart below shows the average variable cost function. It's a U-shaped curve. Initially, the variable cost per unit of output decreases as output increases. At one point, it reaches a low. After the low, the variable cost per unit of output starts to increase. The increase in AVC after a certain point is indirectly related to the law of diminishing marginal returns. The law states that at some point, the additional cost incurred to produce one more unit is greater than the additional revenue (or returns) received. At that point, the AVC starts to increase.

Average Variable Cost Function

The average variable cost (AVC) can be determined with the following equation:


Where AVC is the average variable cost

TVC is the total variable cost

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Additional Activities

Extra Questions/Problems for Average Variable Cost

Consider the following costs for a pizzeria. Are these costs fixed costs or variable costs?

  • Rent for the building that is being leased by the firm.
  • The cost of the dough used to make the pizza.
  • The wages paid to the workers at the pizza shop.
  • The money that is due to repay the pizza oven that was leased.
  • Electricity costs.

Use the following equation for the total variable cost to answer the questions that follow.

VC = 100Q + 2Q2

  1. What is the equation of the average variable cost?
  2. What is the average variable cost when no units of output are being produced?
  3. What is the average variable cost when 10 units are being produced?
  4. What is the average variable cost when 20 units are being produced?

Additional Questions.

  1. True/False. When the firm produces no output, the average variable cost equals zero.
  2. True/False. The average variable cost is always increasing with output.
  3. True/False. In the short run, the average variable cost is used to determine if the firm should shut down or continue to operate.
  4. True/False. In the long run, the average variable cost is equal to the average total cost.
  5. True/False. The average variable cost can be used to determine profitability.

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