The "law" of Average Fixed Cost (AFC) isn't a law in the traditional sense, but rather a predictable behavior: AFC always declines as output increases because fixed costs are spread over a larger number of units.
Here's a breakdown:
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What is Average Fixed Cost (AFC)? AFC represents the fixed cost per unit of output. It is calculated by dividing total fixed costs (TFC) by the quantity of output (Q):
AFC = TFC / Q -
Total Fixed Costs (TFC): These costs remain constant regardless of the level of production. Examples include rent, insurance premiums, and salaries of permanent staff.
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The Relationship: Since TFC is constant, as the quantity of output (Q) increases, the AFC will inevitably decrease. This is because the fixed cost is being distributed across more units.
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Example: Imagine a company has a monthly rent of $1,000 (TFC).
- If the company produces 100 units, the AFC is $1,000 / 100 = $10 per unit.
- If the company produces 200 units, the AFC is $1,000 / 200 = $5 per unit.
- If the company produces 1000 units, the AFC is $1,000 / 1000 = $1 per unit.
As you can see, AFC continuously declines as production increases.
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Graphical Representation: The AFC curve is a downward-sloping curve. It approaches the x-axis (quantity) as output increases, but it never actually touches it (it's asymptotic).
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Important Note: While decreasing AFC is generally desirable, it's crucial to consider other costs (variable costs) to determine the optimal level of production. Focusing solely on minimizing AFC can lead to overproduction and reduced profitability if variable costs increase disproportionately. The total cost picture, including average variable cost (AVC) and average total cost (ATC) needs to be analyzed.
In summary, the "law" of AFC highlights the inverse relationship between output and average fixed costs: as production increases, the average fixed cost per unit decreases because the fixed costs are spread across a greater number of units.
