This study note provides a short introduction to fixed and variable costs for businesses in the short run
What is meant by the short run?
In the short run, at least one factor of production is fixed.
This means that output can be increased by adding more variable factors such as employing more workers and buying in more raw materials
What are fixed costs?
Fixed costs are the overhead costs of a business.
Total fixed costs (TFC)
Average fixed cost (AFC) = TFC / output
Average fixed costs must fall continuously as output increases because total fixed costs are being spread over a higher level of production.
A change in fixed costs has no effect on marginal costs. Marginal costs relate only to variable costs!
What are Variable Costs?
Variable costs vary directly with output – when output is zero, variable costs will be zero but as production increases, total variable costs will rise
Examples of variable costs include the costs of raw materials and components, packaging and distribution costs, the wages of part-time staff or employees paid by the hour, the costs of electricity and gas and the depreciation of capital inputs due to wear and tear
Average variable cost
(AVC) = total variable costs (TVC) /output (Q)
Total Cost (TC)
Total cost = fixed costs + variable costs
Average Total Cost (ATC or AC)
Calculating Costs – A Numerical Example
A numerical example of short run costs is shown in the table below. Fixed costs are assumed to be constant at £200. Variable costs increase as more output is produced.
|Output (Q)||Total Fixed Costs (TFC)||Total Variable Costs (TVC)||Marginal Cost (the change in total cost from a one unit change in output)|
|(TC= TFC + TVC)||(AC = TC/Q)|
In our example, average cost per unit is minimised at a range of output - 350 and 400 units.
Thereafter, because the marginal cost of production exceeds the previous average, so average cost rises (for example the marginal cost of each extra unit between 450 and 500 is 4.8 and this increase in output has the effect of raising the cost per unit from 1.8 to 2.1).
An example of fixed and variable costs in equation format
If for example, the short-run total costs of a firm are given by the formula
SRTC = $(10 000 + 5X2) where X is the level of output.
The firm’s total fixed costs are $10,000
The firm’s average fixed costs are $10,000 / X
If the level of output produced is 50 units, total costs will be $10,000 + $2,500 = $12,500