Understanding Average Fixed Cost (AFC)
Average Fixed Cost is total fixed costs divided by the quantity produced. Because fixed costs don't change with output, AFC continuously decreases as production volume increases — a fundamental principle of economics called "spreading overhead."
Manufacturing economists call the inverse relationship between volume and AFC the "scale advantage." A factory that doubles production from 1,000 to 2,000 units cuts AFC in half, which is why high-volume producers can undercut competitors on price while maintaining profitability.
Cost Breakdown Reference Table
| Cost Metric | Formula | Behaviour as Q Increases |
|---|---|---|
| AFC | FC / Q | Decreases (hyperbolic) |
| AVC | VC / Q | U-shaped (typically constant short-run) |
| ATC | TC / Q = AFC + AVC | U-shaped |
| Marginal Cost | ΔTC / ΔQ | U-shaped, crosses ATC at its minimum |
Key Formulas
Pricing Implications
Setting price above ATC generates profit. Setting price above AVC but below ATC covers variable costs and contributes to fixed cost recovery — viable short-term but not sustainable. Setting price below AVC means every unit sold increases losses.
Fixed vs. Variable Cost Examples
| Fixed Costs | Variable Costs |
|---|---|
| Rent, lease payments | Raw materials |
| Salaried management | Direct labour (per-unit) |
| Insurance premiums | Packaging |
| Equipment depreciation | Shipping |