Definition of Average Fixed Cost
Average fixed cost (AFC) is defined as the fixed cost of production divided by the quantity of output. It is sometimes also referred to as fixed cost per unit of output or per-unit fixed cost. That means it describes the sum of all expenses and costs that don’t change as output increases or decreases, divided by the number of goods or services produced. Starting from there, AFC can be represented by the following formula:
Let’s say an imaginary car manufacturer called Super Cars produces 100 pick-up trucks every month. For the sake of this example, we’ll assume that the company only has two types of fixed costs: rent and wages. More specifically, Super Cars has to pay USD 5,000 monthly rent for the factory building. In addition to that, the firm pays its employees a total of USD 45,000 in salaries per month. Thus, the total fixed costs per month add up to USD 50,000.
Now, to calculate AFC all we need to do is divide total fixed cost we just calculated above (i.e. USD 50,000) by the number of trucks produced (i.e. 100 trucks). This results in AFC of USD 500 per truck. Or in other words, when Super Cars produces 100 vehicles per month, it has to incur per-unit fixed costs of USD 500 for each truck it produces.
Why Average Fixed Cost Matter
AFC plays an important role when it comes to production decisions. As we know, fixed costs must be incurred regardless of the level of output produced. However, AFC decrease as the quantity of output increases. The reason for this is that the fixed costs can be spread across more units as output increases. Therefore, firms must always consider AFC and how they change as output changes if they want to maximize profit.