Average Cost (Per Unit Cost)

Marginal Cost Analysis: Fixed Cost vs. Variable Cost Per Unit

The total cost of production can be segmented into two distinct types of costs, which are differentiated by their relationship (or lack thereof) with the volume of output.

1. Fixed Cost → Fixed costs remain the same irrespective of the production volume, i.e. they are independent of the unit output.
2. Variable Cost→ Variable costs fluctuate based on the output of production, i.e. an increase in production volume coincides with higher variable costs (and vice versa).

Initially, the average cost tends to decline as more units are produced—i.e. economies of scale—but the cost savings and benefits to a company’s profit margins reverse course beyond a certain threshold in terms of unit production output.

Near the aforementioned inflection point, most of the incurred incremental per-unit costs are of variable nature, rather than fixed costs. Therefore, companies must establish set internal targets regarding the number of units to produce (and sell to the market) in order to operate at a level where profitability is near maximized.

Otherwise, the positive effects of economies of scale start to diminish as the marginal benefit derived from the production of each incremental unit declines (and the marginal cost per unit causes profits to decline).

• Marginal Cost < Average Cost: Increased Production Output → Lower Average Cost
• Marginal Cost > Average Cost: Decreased Production Output → Higher Average Cost

Average Cost Calculator – Excel Template

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

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Average Cost Calculation Example (Per-Unit Cost)

Suppose an OEM equipment manufacturer produced a total of 25,000 parts and components in the fiscal year ending 2022.

Amid the conversion of raw materials it purchased into finished goods ready to be sold to its customers, the manufacturer incurred a total of $500,000 in fixed costs.

• Total Number of Units Produced (Q) = 25,000
• Total Fixed Costs = $500,000

Moreover, the variable cost per unit of production is $4.00, so the total variable costs incurred over the course of the fiscal year were $100,000.

• Variable Cost Per Unit = $4.00
• Total Variable Costs = $4.00 × 25,000 = $100,000

The sum of the manufacturer’s fixed and variable costs, i.e. the total cost of production, comes out to $600,000.

• Total Cost of Production (TC) = $500,000 + $100,000 = $600,000

In the final step of our exercise, the total cost of production is divided by the total quantity of units produced to arrive at an average cost of $24.00.

• Average Cost Per Unit = $600,000 ÷ 25,000 = $24.00