Average fixed cost decreases with additional production. The logic behind this relation is relatively simple. Because fixed cost is FIXED and does not change with the quantity of output, a given cost is spread more thinly per unit as quantity increases. A thousand dollars of fixed cost averages out to $10 per unit if only 100 units are produced. But if 10,000 units are produced, then the average shrinks to a mere 10 cents per unit.

Average fixed cost, when combined with price, indicates whether or not a firm should shut down production in the short run. If price is greater than average fixed cost, then the firm is able to pay, at least, fixed cost. Even though it might be incurring an economic loss, it will lose less by producing than by shutting down production. If, however, price is less than average fixed cost, then the firm is better off shutting down production.

Calculating Average Fixed Cost

average fixed cost

=

total fixed cost quantity of output

average fixed cost = average total cost - average variable cost

total fixed cost = average fixed cost x quantity of output

Stuffed Animal Cost

Average Fixed Cost

Deriving average fixed cost is as simple as dividing the second column of total fixed cost values by the first column of output quantity values. The average fixed cost of producing 1 Stuffed Amigo is relatively easy--divide $3 by 1 Stuffed Amigo. If the result of this calculation is not readily obvious, click the [One] button.

The average fixed cost of two Stuffed Amigos might be a little less obvious, but not much. Click the [Two] button to reveal that the average fixed cost is $1.50, which is $3 divided by 2 Stuffed Amigos. A click of the [Three] shows that the average fixed cost of producing 3 Stuffed Amigos is $1, $3 divided by 3. The remaining average fixed cost values can be displayed by clicking the [Remaining] button.

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

• First, average fixed cost is high at relatively small output quantities and low at relatively large output quantities. The reason, of course, is that as output increases, a given fixed cost is spread more thinly over a larger quantity.


• Second, average fixed cost remains positive, it never reaches a zero value and never turns negative. The only way for negative average fixed cost is for negative total fixed cost, which makes neither theoretical nor practical sense.

The Average Fixed Cost Curve

Average Fixed Cost Curve