Definition
Average Fixed Cost (AFC) refers to the total fixed costs of production spread out over the quantity of output produced. AFC is calculated by dividing the total fixed costs (TFC) by the number of units produced (Q). It helps firms understand how fixed costs per unit decrease as production levels increase due to the spreading effect.
Formula:
\[ \text{AFC} = \frac{\text{Total Fixed Costs (TFC)}}{\text{Quantity of Output (Q)}} \]
Examples
-
Calculate AFC for a manufacturing plant:
- Total Fixed Costs (TFC): $10,000
- Units Produced (Q): 1,000
- Average Fixed Cost (AFC): $10,000 / 1,000 = $10 per unit
-
Small scale bakery:
- TFC include rent, insurance, and salaries of permanent staff: $5,000/month
- Bread loaves produced (Q): 2,500
- AFC: $5,000 / 2,500 = $2 per loaf
Frequently Asked Questions
Q1: What is the difference between fixed costs and variable costs?
Fixed costs remain constant regardless of the level of output, such as rent or salaries of permanent staff. Variable costs, on the other hand, vary directly with production volume, such as raw materials and labor directly involved in production.
Q2: Why does Average Fixed Cost decrease as output increases?
AFC decreases with increased output because the total fixed cost is distributed over more units, thereby lowering the fixed cost per unit.
Q3: How can understanding AFC help a business manager?
Understanding AFC helps managers make informed decisions about scaling production, pricing strategies, and understanding cost behavior with changes in output levels.
- Fixed Cost: Costs that do not change with the level of production or sales, such as rent, salaries, and loan payments.
- Variable Cost: Costs that change in proportion to the level of production or sales, such as cost of raw materials and direct labor.
- Average Cost (AC): Total cost divided by the number of units produced. It includes both fixed and variable costs.
- Total Cost (TC): The sum of total fixed costs and total variable costs at different levels of output.
Online References
Suggested Books for Further Studies
- “Managerial Accounting” by Ray H. Garrison, Eric W. Noreen, Peter C. Brewer
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, Madhav V. Rajan
- “Principles of Economics” by N. Gregory Mankiw
Fundamentals of Average Fixed Cost: Economics Basics Quiz
### AFC is calculated by dividing the total fixed cost by what?
- [ ] Total variable cost
- [x] Quantity of output
- [ ] Total revenue
- [ ] Total cost
> **Explanation:** AFC is calculated by dividing the Total Fixed Costs (TFC) by the Quantity of Output (Q). AFC = TFC / Q.
### What happens to AFC as production increases?
- [x] It decreases
- [ ] It increases
- [ ] It stays the same
- [ ] It depends on variable costs
> **Explanation:** AFC decreases as production increases because the fixed costs are spread over more units of output.
### What does 'fixed' in fixed costs refer to?
- [ ] They change with production levels
- [x] They do not change with production levels
- [ ] They vary with revenue
- [ ] They are fixed to a price index
> **Explanation:** 'Fixed' in fixed costs means that these costs do not change with the level of production or sales, unlike variable costs.
### If total fixed costs are $6,000 and 1,200 units are produced, what is the AFC?
- [x] $5 per unit
- [ ] $0.50 per unit
- [ ] $7 per unit
- [ ] $10 per unit
> **Explanation:** AFC = TFC / Q. So here, AFC = $6,000 / 1,200 = $5 per unit.
### What type of cost does AFC belong to?
- [ ] Variable Cost
- [ ] Marginal Cost
- [x] Fixed Cost
- [ ] Opportunity Cost
> **Explanation:** AFC is a measure of fixed costs distributed across the quantity of output units.
### Which cost does not change with the level of production?
- [ ] Total variable cost
- [ ] Average variable cost
- [x] Total fixed cost
- [ ] Marginal cost
> **Explanation:** Total Fixed Cost does not change with the level of production. It remains constant irrespective of output levels.
### The AFC curve typically has what kind of shape?
- [ ] Upward-sloping
- [ ] U-shaped
- [ ] Downward-sloping
- [x] Rectangular hyperbola
> **Explanation:** The AFC curve is a downward-sloping rectangular hyperbola, as AFC decreases with increasing output.
### What influences the rate at which AFC decreases?
- [ ] Total Revenue
- [ ] Selling Price
- [x] Quantity of output
- [ ] Total Cost
> **Explanation:** The rate at which AFC decreases is influenced by the Quantity of Output. As Q increases, AFC decreases.
### AFC is part of which broader cost category?
- [x] Overhead Costs
- [ ] Direct Costs
- [ ] Incremental Costs
- [ ] Marginal Costs
> **Explanation:** AFC is part of Overhead Costs, as it comprises components like rent and salaries that do not vary directly with production levels.
### Why is understanding AFC important for businesses?
- [ ] It determines selling price.
- [ ] It helps in budgeting variable costs.
- [ ] It is used for optimizing variable costs.
- [x] It helps in understanding cost behavior in relation to output levels.
> **Explanation:** Understanding AFC helps businesses comprehend how fixed costs are spread out over different levels of production, influencing decision-making related to scaling and pricing.
Thank you for exploring the fundamentals of Average Fixed Cost with us. Good luck with your studies in the field of economics!
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