What is Average Cost?
The Average Cost, or “per unit cost”, is an economic term that describes the approximate cost incurred to manufacture one production unit.
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How to Calculate Average Cost (Per Unit Cost)
The average cost represents the standard cost incurred per unit of production.
The calculation of the average cost is relatively straightforward, since the per-unit cost represents the ratio between the total cost of production and the total number of production units.
The importance of measuring the average cost is tied to setting the pricing of products appropriately, wherein enough profits are generated per sale for the company’s operations to remain sustainable.
In theory, the price point at which a good is sold should be based on the current state of the market conditions (i.e. supply and demand), which is a fundamental part of researching a particular market, target customer profile, and business model optimization.
The process of determining a company’s average cost is as follows.
- Step 1 → Count the Total Number of Units Produced in a Given Period
- Step 2 → Determine the Total Production Costs Incurred in the Corresponding Period
- Step 3 → Divide the Total Cost of Production by the Total Number of Units Produced
Average Cost Formula (Per Unit Cost)
The formula to calculate the average cost is as follows.
Broadly, the total cost of production is composed of two parts, as expressed by the following formula.
While the total cost of production is often abbreviated as “TC”, the total number of units produced is frequently denoted as “Q”.