Definitions of costs of production: total cost (TC), average total cost (ATC), fixed cost (FC), average fixed cost (AFC), variable cost (VC), average variable cost (AVC)

Microeconomic Decision‑Makers – Firms' Costs, Revenue and Objectives

Definitions of Costs of Production

Cost TypeDefinition & Formula
Total Cost (TC)

The total amount of money a firm spends to produce a given quantity of output.

\$TC = FC + VC\$

Fixed Cost (FC)

Costs that do not change with the level of output (e.g., rent, insurance).

\$FC = \text{constant for all } Q\$

Variable Cost (VC)

Costs that vary directly with the level of output (e.g., raw materials, labour).

\$VC = \text{increases as } Q \text{ increases}\$

Average Total Cost (ATC)

The cost per unit of output.

\$ATC = \dfrac{TC}{Q}\$

Average Fixed Cost (AFC)

The fixed cost spread over each unit of output.

\$AFC = \dfrac{FC}{Q}\$

Average Variable Cost (AVC)

The variable cost per unit of output.

\$AVC = \dfrac{VC}{Q}\$

🍕 Analogy: Think of a pizza shop. The rent for the shop is a fixed cost – it stays the same whether you sell 10 or 100 pizzas. The flour, cheese, and pizza‑topping costs are variable costs – they grow as you bake more pizzas. The total money spent on rent and ingredients is the total cost. If you divide the total cost by the number of pizzas sold, you get the average total cost per pizza. Similarly, dividing the rent by the number of pizzas gives the average fixed cost, and dividing the ingredient costs by the number of pizzas gives the average variable cost.

Exam Tips

📌 When analysing a cost graph:

  • Locate the point where ATC is lowest – that’s the efficient scale of production.

  • Remember that AFC always falls as output rises because the fixed cost is spread over more units.

  • After the point of diminishing returns, AVC will start to rise, causing ATC to rise as well.

  • In a short‑run analysis, if the price falls below AVC, the firm should shut down temporarily.