Suppose, Kapil Khurana incurs an expenditure of Rs. 20,000/- on installing a stone cutter machine. If he cuts 10,000 pieces of stones during the first month of installation, the average fixed cost will be Rs. 20,000/10,000 = Rs. 2. When the number of pieces he cuts increases to 20,000, the average fixed cost falls to Rs. 1. Thus, as the level of output increases, the average fixed cost falls. It is clear from the Fig. 9.3 given below.
Total fixed cost is a constant quantity. As the output increases, the total fixed cost spreads out over more and more units and therefore average fixed cost becomes lesser and lesser. When output becomes very large, average fixed cost approaches zero. Business Executives refer to it as ‘speeding the overheads’.
It will be seen that average fixed cost (AFC) falls continuously, as more units are being produced at the same fixed expenses. AFC corresponding to any point on the TFC curve is equal to the slope of the ray from origin to that point, i.e., perpendicular (total fixed cost) divided by base (total output) or tangent of the angle made by the ray with the X-axis.
Graphically, the average fixed cost curve is a downward sloping curve, since the slope of the ray from origin to any point on TFC curve decreases, as one move to the right. It will fall steeply in the beginning and will tend to touch X-axis, but will never become zero.
Similarly, AFC curve can never touch Y-axis. It is so, because, TFC is a positive value at zero output and any positive value divided by zero will provide infinite value. Thus, AFC curve Approaches both the axes asymptotically.
Further, the nature of AFC curve is rectangular hyperbola indicating that every rectangle (TFC = AFC x Q) will be equal to every other rectangle in area. When the output increases by a certain percentage, the average fixed cost decreases by the same percentage such that their product representing total fixed cost remains constant throughout.