Average cost

In economics, average cost and/or unit cost is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q). Average costs may be dependent on the time period considered (increasing production may be expensive or impossible in the short term, for example). Average costs affect the supply curve and are a fundamental component of supply and demand.

Short-run average cost

Average cost is distinct from the price, and depends on the interaction with demand through elasticity of demand and an average cost due to marginal cost pricing.

Short-run average cost will vary in relation to the quantity produced unless fixed costs are zero and variable costs constant. A cost curve can be plotted, with cost on the y-axis and quantity on the x-axis. Marginal costs are often shown on these graphs, with marginal cost representing the cost of the last unit produced at each point; marginal costs are the slope of the cost curve or the first derivative of total or variable costs.

Average cost method

Under the 'Average Cost Method', it is assumed that the cost of inventory is based on the average cost of the goods available for sale during the period.

The average cost is computed by dividing the total cost of goods available for sale by the total units available for sale. This gives a weighted-average unit cost that is applied to the units in the ending inventory.

There are two commonly used average cost methods: Simple Weighted-average cost method and perpetual weighted-average cost method.

Weighted Average Cost

Weighted Average Cost is a method of calculating Ending Inventory cost. It is also known as WAVCOs

It takes Cost of Goods Available for Sale and divides it by the number of units available for sale (number of goods from Beginning Inventory + Purchases/production). This gives a Weighted Average Cost per Unit. A physical count is then performed on the ending inventory to determine the number of goods left. Finally, this quantity is multiplied by Weighted Average Cost per Unit to give an estimate of ending inventory cost. The cost of goods sold valuation is the amount of goods sold times the Weighted Average Cost per Unit. The sum of these two amounts (less a rounding error) equals the total actual cost of all purchases and beginning inventory.