In general, average total cost decreases with additional production at relatively small quantities of output, then eventually increases with relatively large quantities of output. This pattern is illustrated by a U-shaped average total cost curve.

Average total cost, when combined with price, determines per unit profit or loss that a profit-maximizing firm receives from short-run production. If price is greater than average total cost, then the firm receives positive economic profit per unit. If price is less than average total cost, the firm incurs a loss, or negative economic profit, per unit. If price is equal to average total cost, then the firm is just breaking even, receiving neither a per unit profit nor incurring a per unit loss.

Calculating Average Total Cost

average total cost

=

total cost quantity of output

average total cost = average variable cost + average fixed cost

total cost = average total cost x quantity of output

Stuffed Animal Cost

Average Total Cost

Deriving average total cost is as simple as dividing the second column of total cost values by the first column of output quantity values. The average total cost of producing 1 Stuffed Amigo is relatively easy--divide $8 by 1 Stuffed Amigo. If the result of this calculation is not readily obvious, click the [One] button.

The average total cost of two Stuffed Amigos might be a little less obvious, but not much. Click the [Two] button to reveal that the average total cost is $5.50, which is $11 divided by 2 Stuffed Amigos. A click of the [Three] shows that the average total cost of producing 3 Stuffed Amigos is $4.33, $13 divided by 3. The remaining average total cost values can be displayed by clicking the [Remaining] button.

With all numbers displayed, what interesting insight into average total cost can be had?

• First, average total cost is relatively high for the first Stuffed Amigo produced, then declines. However, it reaches a low, then rises with production of the last few Stuffed Amigos.


• Second, average total cost remains positive, it never reaches a zero value and never turns negative. The only way for negative average total cost is for negative total cost, which makes no theoretical or practical sense.


• Third, the average total cost values in this table are comprised of two parts--average variable cost and average fixed cost. In other words, the $4.60 average total cost of producing 10 Stuffed Amigos can be broken down into something like $4.30 of average variable cost and $0.30 of average fixed cost.

The Average Total Cost Curve

Average Total Cost Curve

The key feature of this average total cost is the shape. It is U-shaped, meaning it has a negative slope for small quantities of output, reaches a minimum value, then has a positive slope for larger quantities. This U-shape is indirectly attributable to the law of diminishing marginal returns.