Average cost

Introduction

Average cost is the cost per unit manufactured in a production run. Economics is a branch of social science which studies the production, distribution & consumption of goods & services. It focuses on the behaviour & interacting economic agents & how the economy works. Cost is one of the important concepts in economics. Cost is an amount incurred for buying goods & services. The concept of cost is useful for calculating the profitable rate of operation of the firm. Also, it is useful for deciding the price of the product & sale channel. Also, it gives clarity to various costs concept. So let’s study costs & various types of costs in brief.

Cost

• Cost is an amount incurred by a firm for the production of goods & delivery of a service.

• This is also referred to as opportunity cost.

• There are different types of costs given as follows −

  • Opportunity cost & actual cost

    Opportunity cost − It is the amount incurred for the production of goods & delivery services.

    Actual cost: It is the actual amount which is incurred the acquire a product.

  • Explicit & implicit cost

    Explicit cost − It is an amount spent to buy or hire resources for the production of goods from outside the organisation.

    Implicit cost − It is an amount spent for use of self-owned resources of an organization used for the production of goods.

  • Direct & indirect cost:

    Direct cost − Costs which can directly be accountable to specific cost objects such as process or product.

    For example, Wages of labour, material etc.

    Indirect cost − Costs which cannot be directly accountable to specific cost object or irrelevant to production.

    For example, Insurance, maintenance, telecom etc.

  • Fixed cost & variable cost

    Fixed cost − The costs doesn’t change with respect to output level are known as fixed cost or sales revenue.

    Variable cost − The costs which are depends on the production volume of company. These costs are varying.

  • Marginal cost

    Marginal cost is the change in the total cost due to increase of production of quantity.

Average cost

• Average cost is the ratio of cost of all the products to the total number of products.

• It indicates the average amount spent in the manufacturing of product.

• It can be calculated by using following formula

  $$\mathrm{Average\: cost = \frac{Total\: cost\: of\: all\: products}{No.of\: products}=\frac{\sum_i^nx_i}{Q}}$$

  Here ∑ⁿx_i = Sum of cost of products

  Q = Quantity of products

• This amount can vary depending on the number of units produced.

• It is also known as unit cost.

• In order to find price standard margin is added to average cost price.

• Average cost decreases if number of units produced increases.

Steps to calculate average cost

• First determine the fixed cost of production.

• Find the variable cost of production

• Then add the total fixed cost & total variable cost

• Find out the quantity of units produced.

• Compute the average total cost of production by using following formula,

  $$\mathrm{Average\: cost = \frac{Total\: cost\: of\: all\: products}{No.of\: products}=\frac{\sum_i^nx_i}{Q}}$$

Selling price

The price at which any product is sold is known as the selling price. For example, the shopkeeper bought mangoes at ₹ 200 per kg and sold mangoes at ₹ 300 per kg. Therefore, Rs. 300 is the selling price of mangoes. In order to earn profit, any product should be sold at an average cost price.

Steps for calculating the selling price per unit

Step 1: Identify the total cost of units.

Step 2: For calculating cost of each unit, divide the total cost by number of units.

Step 3: To find out the final price, use the following formula

Selling price = Cost price + Profit margin

Step 4: In order to identify the appropriate pricing margin should be added to the cost of units.

Some important formulas for calculating selling price

• Selling price = Cost price + Profit

• Selling price = Marked or list price - Discount

• Selling price =$\mathrm{=\frac{(100+ \% profit)}{100}×cost\: price}$

• Selling price =$\mathrm{=\frac{(100- \% profit)}{100}×cost\: price }$

Profit

If selling price is more than cost price, then there is a gain is called as profit. To make any deal profitable, then you should sell a product over the cost price otherwise, you will incur a loss. In the case of average cost price, you should sell a product at the average cost price or over the average cost price to get a profit.

For example, If the shopkeeper bought a bucket at ₹ 35. He sells a bucket at ₹ 40, ₹ 42 ₹ 44 & ₹ 46. The average price of bucket is ₹ 43. To earn profit he should sell a bucket at ₹ 43.

Solved examples

1) Calculate the average price of 10 books whose price are 110, 120, 130, 135, 140, 145, 150, 155 & 160.

$$\mathrm{Average\: cost = \frac{Total\: cost\: of\: all\: products}{No.of\: products}=\frac{\sum_i^nx_i}{Q}}$$

$$\mathrm{=\frac{110+120+130+135+140+145+150+155+160}{10}}$$

$$\mathrm{=\frac{1245}{10}}$$

=124.5

Therefore, the average cost of 10 books is ₹ 124.5.

2) A bag contains five toys. the cost of each toy is ₹ 250. Find the average cost of each ball.

Answer:

Given

Total cost (TC) = ₹ 250

Quantity (N) = 5

Average cost =?

$$\mathrm{Average\: cost = \frac{Total\: cost}{Quantity}=\frac{TC}{N}=\frac{250}{5}=50}$$

Therefore, the average cost of toys is ₹ 50.

Conclusion

This tutorial covers a topic average cost along with solved examples. This tutorial includes costs, different types of costs, average cost, selling price, profit with solved examples. Cost is an amount spent for purchase any product. There are different types of costs, average cost, marginal cost, implicit & explicit cost, opportunity & actual cost, fixed cost & variable cost. Average cost is the ratio of costs of all products to the total quantity.

In order to earn profit, you should sell a product at a price greater than the average cost.

FAQs

1. What are short- run average cost & long- run average cost?

Short - run average costs

• These average costs vary with the production of goods.

• Fixed costs are considered as zero & variable costs are constant.

Long - run average cost

• It is unit cost of which involves all the cost of the quantities.

• All the inputs may vary.

• It is useful to determine economies of scale of firm.

2. State whether the following statement is true false.

The average total cost has U - shaped curve.

True

3. What is a marginal revenue?

Revenue obtained from the sales of additional product is called as marginal revenue. It can be calculated by using following formula

4. What is normal profit?

It is minimum return on investment which producer expects from capital in business.

5. What is the relationship between marginal revenue & total revenue?

Total revenue is high when the marginal revenue is zero & when marginal revenue is negative total revenue starts to fall.