Costs: Fixed, Variable & Total Costs - PDF

COSTS FIXED COSTS Costs that stay the same at all levels of output in the short run are called fixed costs. Examples might be rent, insurance, heating bills, depreciation and business rates, as well as capital costs, such as factories and machinery. These costs remain the same whether a business p...

COSTS FIXED COSTS Costs that stay the same at all levels of output in the short run are called fixed costs. Examples might be rent, insurance, heating bills, depreciation and business rates, as well as capital costs, such as factories and machinery. These costs remain the same whether a business produces nothing or is working at full capacity. For example, rent must still be paid even if a factory is shut for a 2-week holiday when nothing is produced. Importantly, 'fixed' here means costs do not change as a result of a change in output in the short run. But they may increase due to, say, inflation. Figure 4 shows what happens to fixed costs as a firm increases production. The line on the graph is horizontal which shows that fixed costs are £400,000 no matter how much is produced. The firm is a doll manufacturer. VARIABLE COSTS Costs of production, which increase directly as output rises are called variable costs. For example, a baker will require more flour if more bread is produced. Raw materials are just one example of variable costs. Others might include fuel, packaging and wages. If the firm does not produce anything then variable costs will be zero. Figure 6 shows the variable costs of the doll manufacturer mentioned above. Variable costs are £2 per doll. If the firm produces 100,000 dolls it will have variable costs of £200,000 (£2 x 100,000). Producing 600,000 dolls will incur variable costs of £1,200,000 (£2 x 600,000). Joining these points together shows the firm's variable costs at any level of output. As output increases, so do variable costs. Notice that the graph is linear. This means that it is a straight line. TOTAL COST If fixed and variable costs are added together they show the total cost of a business. The total cost of production is the cost of producing any given level of output. As output increases total costs will rise. This is shown in Figure 7, which again shows the production of dolls. We can say: Total cost(TC) = Fixed cost (FC) + Variable cost (VC) The business has fixed costs of £400,000and variable costs of £2 per doll. When output is 0, total costs are £400,000. When output has risen to300,000 dolls, total costs are £1,000,000, made up of fixed costs of £400,000 and variable costs of £600,000 (£2 x 300,000). When output is 600,000, total costs are £1,600,000, made up of fixed costs of £400,000 and variable costs of £1,200,000(£2 x 600,000). Figure 7 shows the way that total costs increase as output increases. Notice that as output increases fixed costs become a smaller proportion of total costs. AVERAGE COST OR UNIT COST The average cost is the cost per unit of production, also known as the unit cost. To calculate average cost, the total cost of production should be divided by the number of units produced, or output. Average cost =. Output Total cost PROFIT AND LOSS One of the main reasons why firms calculate their costs and revenue is to enable them to work out their profit or loss. Profit is the difference between revenue and costs. Profit = Total revenue- Total costs