Average Variable Costs

Average variable costs (AVC) represent the ratio of total variable costs (VC) to the quantity of output produced (Y). They are a fundamental component of average cost.

AVC = VC / Y

Graphically, the behavior of average variable costs reflects the principles of diminishing returns and factor productivity.

At low levels of output (Y), the marginal productivity of inputs tends to increase. In this phase, a given increase in variable costs (ΔVC) results in a more than proportional rise in output (ΔY). Consequently, the average variable cost curve (AVC) slopes downward. However, beyond a certain production threshold, diminishing marginal productivity sets in. At this point, additional input usage (ΔVC) generates a less than proportional increase in output (ΔY), causing AVC to rise. This results in the characteristic U-shaped curve of average variable costs.

Variable Costs and Production. In the short run, the only way to increase output (ΔY) is by employing more variable inputs, which directly raises variable costs (ΔVC). Fixed costs, on the other hand, remain constant and do not fluctuate with production levels.

Marginal Productivity and Marginal Cost. There is a direct relationship between marginal productivity and marginal cost. When marginal productivity rises, marginal cost declines; when marginal productivity falls, marginal cost increases. Importantly, marginal cost reaches its minimum precisely at the point where marginal productivity is at its peak.