The average variable cost (AVC) is calculated by dividing the firm’s variable costs by the output or quantity that has been produced. The average total cost, on the other hand, is calculated by dividing the total cost by the output or quantity of goods that have been produced.
It is important to note that the total cost of a firm is a combination of both variable costs (labor and electricity) and fixed costs (buildings and equipment). Variable costs increase proportionally to the number of items produced, while the fixed costs are spread among the items as production increases.
At the start of production, fixed costs are higher than the variable costs but as production increases the variable costs increase. Thus, as quantity increases, both the variable costs and, consequently, the total costs will continue to increase. The situation forces the ATC and AVC curves to move closer to each other as the quantity continues to increase.
To start with, you must remember that the average total cost is made up of the average variable cost and the average fixed cost. Variable costs are those that vary with the amount produced (for example, the cotton that goes into t-shirts) while fixed costs remain the same no matter how many are produced (for example, the sewing machines or the building in which they are produced).
When you are only producing a few t-shirts, for example, the fixed costs make up most of the average total cost. You've paid a lot for the machines and the building, but you're only making a few shirts so you don't have to pay much for the cotton.
But now you start working at 100% capacity. You're buying lots of cotton and paying your workers lots of money. But the fixed costs have remained the same. Because of that, the variable costs are coming to be a much greater part of your total costs.
So -- this happens because as you make more of a product your fixed costs become lower in comparison to your variable costs.