The average cost is the average price of goods and services. When we have multiple products to sell or buy, of almost the same value, the average of these values will give the average cost price. It helps shopkeepers in the buying and selling process.
The average cost is the ratio of the total of cost of all the products to the total number of products. In Maths, we also have the term called “average”. The average of any given set of data is called the mean of data. But in case of business, where profit and loss are the key features, the average is said to be the right term.
Average Cost Formula
The formula for calculating average cost is given by;
Average cost = Total cost of the units/Number of units
The average cost deals with the summation of arithmetic cost divided by the number of the quantity or the number of items given. The formula to calculate the average cost is given here.
X = ∑(xi)/n
Where xi is the sum of all costs and n is the number of items.
The symbol ‘∑’ (called sigma) is used to denote the summation.
How to Calculate Average Cost?
We have already discussed the formula to calculate the average cost. Let us see an example to find the average cost.
Example: Find the average cost of price of 11 bags whose prices are Rs.500, Rs.550, Rs. 450, Rs. 510, Rs. 520, Rs. 530, Rs. 540, Rs. 460, Rs. 470, Rs. 480 and Rs. 490.
Solution: Given, the cost price of 11 bags are:
Rs.500, Rs.550, Rs. 450, Rs. 510, Rs. 520, Rs. 530, Rs. 540, Rs. 460, Rs. 470, Rs. 480 and Rs. 490.
Hence, as per the average cost formula, we know;
Average = Sum of all the cost of bags/Total number of bags
A = (500+550+450+510+520+530+540+460+470+480+490)/11
A = 5500/11
A = 500
Therefore, Rs. 500 is the average cost of 11 bags.
Average Cost and Marginal Cost
By the definition of average cost, we know it is the ratio of the total cost to the number of manufactured products. The total cost here is also termed as unit cost, which is equal to the sum of fixed cost and variable cost.
Average cost = Total cost/Number of units = (Fixed cost + Variable cost)/Number of units
Whereas, marginal cost is the cost incurred due to the change in the total cost because of an increase in the number of products. Hence, it is the additional cost, because of the manufacturing of extra products.
It is helpful for businesses to know whether it is beneficial to produce extra units of products or not. The marginal cost is given by;
MC = Change in cost/Change in quantity