What are the average fixed cost, average variable cost and average cost of a firm? How are they related?

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> [!TLDR]
> Average fixed cost (AFC) is fixed cost per unit, average variable cost (AVC) is variable cost per unit, and average cost (AC) is total cost per unit. They are related by the identity $	ext{AC} = 	ext{AFC} + 	ext{AVC}$, which reflects the fact that total cost is the sum of fixed and variable costs.

When a firm produces output, it incurs two broad categories of cost: fixed costs that do not change with output (rent, insurance, salaries of permanent staff) and variable costs that rise with production (raw materials, hourly wages, electricity for machines). The average cost concepts simply express these on a per-unit basis, giving the firm a clear picture of what each unit of output "costs" on average.

**Average Fixed Cost (AFC)** is the fixed cost spread over the number of units produced. If a firm has fixed cost $	ext{FC}$ and produces $Q$ units, then

$$	ext{AFC} = \frac{	ext{FC}}{Q}.$$

Because the numerator is constant, AFC falls continuously as output rises—the fixed burden is shared across more and more units. This is the phenomenon of "spreading overhead." At very high output levels, AFC becomes negligibly small, though it never reaches zero.

**Average Variable Cost (AVC)** is the variable cost per unit of output:

$$	ext{AVC} = \frac{	ext{VC}}{Q}.$$

Unlike AFC, AVC typically has a U-shape. Initially it falls as the firm benefits from better utilization of variable inputs (increasing marginal returns), reaches a minimum, and then rises as diminishing returns set in and each additional unit requires disproportionately more variable input.

**Average Cost (AC)**, also called average total cost, is the total cost per unit:

$$	ext{AC} = \frac{	ext{TC}}{Q} = \frac{	ext{FC} + 	ext{VC}}{Q}.$$

Splitting the fraction gives us the fundamental relationship between the three averages.

> [!FORMULA]
> $$	ext{AC} = 	ext{AFC} + 	ext{AVC}$$

This identity tells us that the average cost curve is the vertical sum of the AFC and AVC curves. Graphic

Cost	Symbol	Definition
Total Fixed Cost	TFC	Cost that does not change with output (rent, insurance, interest on loans)
Total Variable Cost	TVC	Cost that changes with output (raw materials, wages of daily workers, electricity)
Total Cost	TC	$TC = TFC + TVC$

Q.What are the average fixed cost, average variable cost and average cost of a firm? How are they related?

Concept understanding — Cost Concepts

Cost Concepts: From Everyday Intuition to Economic Precision

The Core Idea: Opportunity Cost

Explicit vs Implicit Costs

Total, Average, and Marginal Costs

Total Cost (TC)

Average Cost (AC)

Marginal Cost (MC)

Short-Run vs Long-Run Costs

Short-Run Cost Categories

The Shape of the Curves

Q.What are the average fixed cost, average variable cost and average cost of a firm? How are they related?

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