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An average fixed cost is the fixed cost per unit of production. When a manufacturer produces goods, it incurs both fixed and variable costs. Fixed costs remain the same regardless of the amount of units produced, while variable costs can increase or decrease. Average fixed cost tends to decrease with a greater number of produced goods.
Fixed costs are related to production and do not typically change. For example, the salary of a plant manager generally remains the same whether the firm produces 200 or 800 units. The manufacturer still has to figure the plant manager's salary into its production costs. Variable costs, such as the cost of raw materials, do change as a result of an increase or decrease in the amount of produced units. If the factory typically produces 200 units, its raw materials costs will be significantly lower than when it produces 800.
The average fixed cost is calculated by taking all of the fixed costs and dividing them by the total amount of units produced. For instance, if a shoe manufacturer has total fixed costs of $1,000 US Dollars (USD) and produces 300 shoes, its average fixed cost would be $3.34 USD per unit. The manufacturer would use this figure to determine whether it should go ahead and produce the shoes or temporarily shut down. As long as the market sales price is higher than average fixed cost, production is financially reasonable.
It does not make sense for a firm to produce goods that are going to cost it more than what it will receive for them. Using the above example, if the shoe manufacturer is only able to sell its shoes for $3 USD per pair, it would not produce at 300 units. The manufacturer would produce at 500 units since its average fixed cost would fall to $2 USD. Production would continue at 500 units even if the manufacturer's total average costs exceeded $3 USD per unit.
The average fixed cost curve is a graphical representation of how a firm's fixed costs tend to decrease as more units are produced. When the number of produced units is low, the slope of the fixed costs tends to be high and decreases sharply as the number of produced units increase. At some point the slope tends to flatten out, with the decreases in costs becoming less and less. The manufacturer tends to see a lower change in the amount of average fixed cost as production levels climb.
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