Average costing is the policy of setting pricing close to the average cost. This is a way to maximize sales even at the expense of higher prices. Average costing happens naturally in markets with perfect completions; however, in the case of oligopolies or monopolies, it happens only when firms make a conscious decision to set costs.
Average costing in a given market is worked out by reconciling the average cost curve and the demand curve by means of a diagram. Additionally, average cost pricing is a means by which a regulating force (such as the government) can keep costs down in a monopolistic environment. Otherwise, monopolies can fix prices and earn unchecked profits. Average costing generally allows the firms to the earn a small profit, rather than charging the cost to produce the product.
The downside of average cost pricing is that the marginal cost of production (i.e., the cost required to produce an extra unit of a product) can be greater than the profit.
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