Final answer:
The average fixed cost (AFC) is calculated by dividing fixed costs by the quantity of output, revealing a downward-sloping curve that represents how overhead is spread over more units as production increases.
Step-by-step explanation:
When analyzing costs in economics and accounting, two vital concepts are fixed costs and overhead. Fixed costs, or overhead, are business expenses that do not change with the level of production or sales. They remain constant even when production levels fluctuate. A well-known example of a fixed cost is the rent paid for a manufacturing facility.
The term “average fixed cost” (AFC) refers to the fixed cost per unit of output produced. It is calculated by dividing the total fixed cost by the quantity of output produced. If we suppose that the fixed cost is $1,000, as the production quantity increases, the AFC decreases because the same amount of fixed cost is “spread” over a larger number of units.
This phenomenon is known as “spreading the overhead” and reflects the diminishing impact of fixed costs on a per-unit basis with increased production.
The average fixed cost curve usually demonstrates a downward slope. At low quantities of output, the AFC is high because the fixed cost is divided among a few units. As output increases, the AFC decreases dramatically, because that same fixed cost is divided among more units. This results in the characteristic hyperbolic shape of the AFC curve, decreasing with each additional unit of output.