Average Cost
Nov 30, 2022, 16:45 IST
An average cost is the average price of both goods and the services. When we have many products to sell or to buy of almost the same values, the average of these values will give the average price. It helps traders in the buying and selling process. The average cost is the ratio of the total cost of all products to the total number of products.
In mathematics, we also have a term called "average." The average of any data set is called the data's mean. But in the case of a business where profit and loss are the main features, the standard is considered the correct term.
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Average Cost Formula
The formula for calculating average cost is given below:
Average cost = Total cost of the units / Number of units
The average cost deals with the summation of arithmetic cost divided by the number of the quantity or the number of items given. The formula to calculate the average cost is given here:
X = ∑(xi) / n
Where xi is the sum of all costs and n is the number of items.
The symbol ‘∑’ (called sigma) is used to denote the summation.
How to Calculate Average Cost?
We have already discussed the formula above to calculate the average cost. Let us consider an example to find the average cost.
Example: Find the average cost of price of 11 bags whose prices are Rs.500, Rs.550, Rs. 450, Rs. 510, Rs. 520, Rs. 530, Rs. 540, Rs. 460, Rs. 470, Rs. 480 and Rs. 490.
Ans. Given, the cost price of 11 bags are:
Rs.500, Rs.550, Rs. 450, Rs. 510, Rs. 520, Rs. 530, Rs. 540, Rs. 460, Rs. 470, Rs. 480 and Rs. 490.
Hence, as per the average cost formula, we know;
Average = Sum of all the cost of bags / Total number of bags
A = (500+550+450+510+520+530+540+460+470+480+490)/11
A = 5500 / 11
A = 500
Therefore, Rs. 500 is the average cost of 11 bags.
Also More Read About- Numbers Names 1 to 100 in Words, Profit and Loss
Average Cost and Marginal Cost
From the definition of average cost, we know that it is the ratio of total cost to the number of products produced. Total cost here is also called unit cost, which is equal to the sum of fixed and variable costs.
Therefore,
Average cost = total cost/number of units = (fixed cost + variable cost)/number of units
Whereas marginal cost is the cost incurred as a result of the change in total cost due to an increase in the no. of products. These are, therefore additional costs due to the production of additional products.
It is useful for businesses to know whether it is beneficial to produce additional units of products or not. Marginal cost is given by the relationship;
MC = Cost Change / Quantity Change
Frequently Asked Question (FAQs)
Q1. Why is it important to know the average cost?
Ans. Understanding the importance of average cost will also help you know how it works for long periods. For example, cost fluctuates depending on seasonal demand and production efficiency. Calculating the average cost normalizes or levels out the cost per unit of production overall.
Q2. What is average cost based on?
Ans. The average cost method assigns costs to inventory items based on the total cost of goods purchased or manufactured during the period divided by the total no. of items purchased or manufactured. The average cost method is also called weighted average method.
Q3. When average cost is maximum?
Ans. The average cost is maximum when the marginal cost exceeds the average. The average cost is equal to total cost divided by the total no. of units produced.
Q4. Can average fixed cost be zero?
Ans. The AFC curve is asymptotic to to both the x and y axis The average fixed cost can never be 0 since fixed cost is positive.
Q5. Is average fixed cost constant?
Ans. Fixed costs are costs of production which are constant whatever the level of output.
