Fixed, variable and total costs of production

Overview

Fixed costs exist only in the short run, electricity bills often described as a semi-variable cost and difference between a sunk cost and a fixed cost.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is the difference between a fixed cost and a variable cost of production?

   Model answer

   Fixed costs do not change with the level of output and must be paid even if the firm produces nothing, examples being rent on premises, business rates, insurance and the salary of a permanent manager. Variable costs change directly with output, examples being raw materials, components, packaging and the wages of workers paid by the hour or by output. Total cost is the sum of the two.

2. 2

   Why do fixed costs exist only in the short run?

   Model answer

   A cost is fixed because the factor generating it cannot be varied within the period, and in the long run every factor can be varied. Given enough time a firm can leave its lease, sell its machinery or close a plant, so every cost becomes escapable. All long-run costs are therefore variable.

3. 3

   A bakery pays 60 pounds a week in rent and rates whatever it bakes, and 8 pounds of ingredients and casual labour per hundred loaves. Classify these costs and write an expression for total cost.

   Model answer

   The 60 pounds is a fixed cost, since it is incurred at every level of output including zero. The 8 pounds per hundred loaves is a variable cost, since it rises in step with output. If Q is output in hundreds of loaves, total cost equals 60 + 8Q pounds per week.

4. 4

   Is the salary of a factory security guard a fixed or a variable cost? Justify your classification.

   Model answer

   It is normally a fixed cost, because the site must be guarded whether the production line runs at full capacity or stands idle, so the cost does not vary with output. It would become variable only if the firm hired guards in proportion to output, for example by staffing extra night shifts as production rose. Classification therefore depends on how the cost actually behaves as output changes, not on the type of worker.

5. 5

   Why are electricity bills often described as a semi-variable cost?

   Model answer

   Part of the bill is a standing charge and the cost of lighting and heating the premises, which is incurred whatever the output level and is therefore fixed. The rest is the power drawn by machinery, which rises as more units are made and is therefore variable. Semi-variable costs must be split into their two components before cost curves can be drawn accurately.

6. 6

   Why does the total variable cost curve start at the origin while the total cost curve does not?

   Model answer

   At zero output the firm buys no raw materials and employs no output-related labour, so total variable cost is zero and the curve begins at the origin. Total cost at zero output equals total fixed cost, which is positive, so the total cost curve starts on the vertical axis at that height. The vertical gap between the two curves is constant and equal to total fixed cost at every level of output.

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