Mastering Fixed Costs and Capital Rental

Fixed cost is a cost that does not vary with the level of output in the short run, while variable cost is a cost that varies with the level of output in the short run. Fixed costs are independent of production activities and can only be avoided if the firm shuts down and exits the industry. Variable cost is defined as the total cost of the variable factors of production at each level of output.

To calculate variable cost at a given level of output, the amount of labor needed to produce that level of output is multiplied by the hourly wage rate. More generally, if L1 is the quantity of labor required to produce an output level of Q1 and w is the hourly wage rate, we have VC(Q1) = wL1.

Total cost is the sum of fixed cost and variable cost. More generally, the expression for total cost of producing an output level of Q1 is written as TC(Q1) = FC + VC(Q1) = rK0 + wL1.