The average variable cost is the amount of money it costs a company to produce a single unit of product. Variable costs are dependent upon on the amount of production required, the cost of labor necessary for production, and the cost of raw materials used in production. To calculate the average variable cost, the total variable costs incurred in a production order are divided by the amount of units in the order. It is important to understand that variable costs are not constant and actually rise and fall as production orders are increased.
Any company that produces some sort of item for the public must be concerned with the cost of producing those items. Fixed costs are incurred independently from production realities, and these include overhead costs like rent that accrue regardless of production. Variable costs are those costs that are associated directly with production, and they vary depending amount on the items produced. The cost incurred to produce a single item is known as the average variable cost.
Calculating the average variable cost of an order requires knowing the amount of items being produced and the variable costs incurred during production. Imagine that a company receives an order to produce 5,000 items and the total variable costs for the order, including materials and labor, will be $10,000 US Dollars (USD). In this case, the average cost for each item produced would be $10,000 USD divided by 5,000 items, which comes to a total of $2 USD per each item produced.
One important thing to consider with the average variable cost computation is that it will change depending upon the amount of items produced. For example, the initial items produced often incur high average costs, perhaps because of the cost of paying labor or using electricity for machinery. These average costs will likely decrease as more items are produced, even as the total variable costs go up with every single unit produced.
Generally, the average variable cost, when charted on a graph, starts out high and decreases for a period before rising again. The curve produced on the graph is U-shaped, meaning that average costs are generally highest in the initial stages of production and when the amount being produced becomes significantly high. By using the average cost curve, a company can determine at what level production yields the most profit. This is done by comparing the variable cost per unit with fixed costs and the price that each item will command.