Fixed and Variable Costs

Fixed and Variable Costs

There are some inputs or factors which can be adjusted with the changes in the output level. Thus, a firm can readily employ more workers if it has to increase output. Likewise, it can secure and use more raw materials, more chemicals, without much delay, if it has to expand production. Thus, labour, raw materials, chemicals are the factors which can be readily varied with the change in output. Such factors are called variable factors. On the other hand, there are factors such as capital equipment, building, top management personnel which cannot be readily varied — it requires a comparatively long time to make variations in them. The factors such as capital equipment, building, which cannot be readily varied and require a comparatively long time to make adjustment in them are called fixed factors. Therefore, fixed costs are those which are independent of output, i.e., they do not change with changes in output. These costs are a “fixed” amount which must be incurred by a firm in the short run, whether the output is small or large. Fixed costs are also known as overhead costs and include charges such as contractual rent, insurance fee, maintenance costs, property taxes, interest on the capital invested, minimum administrative expenses such as manager’s salary, watchman’s wages, etc. Thus, fixed costs are those which are incurred in hiring the fixed factors of production whose amount cannot be altered in the short run.
Variable costs, on the other hand, are those costs which are incurred on the employment of variable factors of production whose amount can be altered in the short run. Thus, the total variable costs change with changes in output in the short run. These costs include payments such as wages of labour employed, the price of the raw material, fuel and power used, the expenses incurred on transporting and the like. Variable costs are also called prime costs. Total cost of a business firm is the sum of its total variable costs and total fixed costs. Thus, TC = TFC+TVC.
In Figure 7.1, output is measured on the X-axis and cost on Y-axis. Since the total fixed cost remains constant whatever the level of output, the total fixed cost curve (TFC) is parallel to the X-axis. This curve starts from a point on the Y-axis meaning thereby that the total fixed cost will be incurred even if the output is zero. On the other hand, the total variable cost curve (TVC) rises upward showing thereby that as the output is increased, the total variable costs also increase. The total variable cost (TVC) starts from the origin which shows that when output is zero the variable costs are also nil. It should be noted that total cost is a function of the total output, the greater the output, the greater will be the total cost. In symbols, we can write:
TC = f(q)
Total cost curve (TC) has been obtained by adding up ‘vertically’ the total fixed cost curve and total variable cost curve because the total cost is a sum of total fixed cost and total variable cost. The shape of the total cost curve (TC) is exactly the same as that of total variable cost curve (TVC) because the same vertical distance always separates the two curves.