Average variable costs mean the total variable costs divided by the number of units produced. The Average variable costs will come down and then rise as more and more units are produced with a given plant. This is because as we add more units of variable factors in a fixed plant, the efficiency of the inputs first increases then it decreases.
The variable factors tend to produce a little more efficient near a firm’s optimum output than a very low levels of output. But once the optimum capacity is reached, any further in output will doubtlessly increase average variable cost quite sharply. Greater output may be obtained but at much greater average variable costs. As for example, if more and more workers are engaged, it may in the end, lead to overcrowding and bad organization.
Even more workers may be required to be paid higher wages for over-time work.
Average Variable (AVC)–Average variable cost can be obtained by dividing total fixed cost (TFC) by the quantity of output (Q),
AFC = TFC/Q
This is illustrated in the following example and diagram:
|Unit of Production||TVC (Rs.)||AVC (Rs.)|
As output, the AVC curves first falls, reaches a minimum and then begins to rise. Thus, AVC curve has a U-shape. Its U-shape can be explained with the help of laws of retunes. Suppose for the optimum utilization of its plant a firm requires 60 laborers. If in the beginning there are only 30 laborers in a firm, out put will rise more than proportionate with the increase in the number of laborers. Because the increase in numbers would enable laborers to utilize the plant more efficiently through division of labor and specialization. Hence average variable cost will fall with the rise in the number of workers and output.
The points of optimum productive-Capacity for the firm will be at 60 laborers. If we would increase the number of laborers beyond this capacity (i.e., after 60 laborers), the average variable cost will rise. Thus in short, up to the point of optimum capacity of the plant operates the law of increasing returns which reduces the average variable cost with the rise in output, and after the point of optimum capacity operates the law of diminishing returns which increases the average variable cost. Thus, the average variable cost curve becomes U-shaped curve. In our example AVC fall up to 4 units of output thereafter it starts of rise.