- Average cost
In

economics ,**average cost**is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (totalvariable costs divided by Q) plus average fixed costs (totalfixed costs divided by Q). Average costs may be dependent on the time period considered (increasing production may be expensive or impossible in the short term, for example). Average costs affect thesupply curve and are a fundamental component ofsupply and demand .**Overview**Average cost is distinct from the

price , and depends on the interaction with demand throughelasticity of demand andelasticity of supply . In cases ofperfect competition , price may be lower than average cost due tomarginal cost pricing .Average cost will vary in relation to the quantity produced unless fixed costs are zero and variable costs constant. A cost curve can be plotted, with cost on the y-axis and quantity on the x-axis.

Marginal costs are often shown on these graphs, with marginal cost representing the cost of the last unit produced at each point; marginal costs are thefirst derivative of average costs.A typical average cost curve will have a U-shape, because fixed costs are all incurred before any production takes place and marginal costs are typically increasing, because of diminishing marginal productivity. In this "typical" case, for low levels of production there are

economies of scale :marginal costs are below average costs, so average costs are decreasing as quantity increases. An increasing marginal cost curve will intersect a U-shaped average cost curve at its minimum, after which point the average cost curve begins to slope upward. This is indicative ofdiseconomies of scale . For further increases in production beyond this minimum, marginal cost is above average costs, so average costs are increasing as quantity increases. An example of this typical case would be a factory designed to produce a specific quantity of widgets per period: below a certain production level, average cost is higher due to under-utilised equipment, while above that level, productionbottlenecks increase the average cost.**Relationship to marginal cost**When average cost is declining as output increases, marginal cost is less than average cost. When average cost is rising, marginal cost is greater than average cost. When average cost is neither rising nor falling (at a minimum or maximum), marginal cost equals average cost.

Other special cases for average cost and marginal cost appear frequently:

* Constant marginal cost/high fixed costs: each additional unit of production is produced at constant additional expense per unit. The average cost curve slopes down continuously, approaching marginal cost. An example may behydroelectric generation, which has no fuel expense, limited maintenance expenses and a high up-front fixed cost (ignoring irregular maintenance costs or useful lifespan). Industries where fixed marginal costs obtain, such as electrical transmission networks, may meet the conditions for anatural monopoly , because once capacity is built, the marginal cost to the incumbent of serving an additional customer is always lower than the average cost for a potential competitor. The high fixed capital costs are abarrier to entry .

*Minimum efficient scale /maximum efficient scale : marginal or average costs may be non-linear, or have discontinuities. Average cost curves may therefore only be shown over a limited scale of production for a given technology. For example, a nuclear plant would be extremely inefficient (very high average cost) for production in small quantities; similarly, its maximum output for any given time period may essentially be fixed, and production above that level may be technically impossible, dangerous or extremely costly. The long runelasticity of supply will be higher, as new plants could be built and brought on-line.

* Low or zero fixed costs / constant marginal cost: since there is noeconomy of scale , average cost will be close to or equal to marginal cost. Examples may include buying and selling ofcommodities (trading)etc....**External links*** [

*http://demonstrations.wolfram.com/LongRunAverageTotalCost/ Long-Run Average Total Cost*] by Fiona Maclachlan,The Wolfram Demonstrations Project .

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