1.2.3 - Fixed, variable, total and average costs

Fixed and variable costs

A business must pay for resources used in production. Classifying a cost depends on how it behaves when output changes over the period considered.

Total fixed costs (TFC) do not change with output in the short run. An illustrative workshop's monthly rent remains £1,200 whether it produces 50 or 100 chairs. It still owes the rent if it produces nothing. Insurance or a salaried manager may also be fixed over that period. Fixed does not mean “unchangeable for ever”: a larger premises or a new contract can change fixed costs later.

Total variable costs (TVC) change with output. More chairs require more wood and packaging, so those costs increase as production rises. In a simple example with £8 of materials per chair, producing 50 chairs costs $50\times£8=£400$; producing 100 costs £800. A constant variable cost per unit gives a variable total that rises in proportion to output, but that constant rate must be stated rather than assumed.

Wages and electricity cannot always be classified from their names. A monthly salary may be fixed; payment per chair made varies with output. A standing electricity charge may be fixed while the electricity used by machines is variable. Read the terms of payment and the period, rather than memorising one label for every bill.

Calculating cost totals

Total cost (TC) is all fixed and variable costs of producing a stated output in a stated period. Add costs measured for the same period; do not add an annual rent to one week's material costs without converting them.

An illustrative bag maker has weekly rent of £300 and insurance of £100, giving $TFC=£300+£100=£400$. It makes 200 bags with material and packaging costs of £3 per bag. $TVC=£3\times200=£600$, so $TC=£400+£600=£1{,}000$. Each total is in pounds per week; output is bags per week. The per-bag material rate and weekly cost total are different quantities.

You can recover a missing total. If another week has total costs of £1,450 and total variable costs of £1,050, fixed costs are $£1{,}450-£1{,}050=£400$. Subtracting identifies the portion that does not vary with that week's output.