While variable costs may initially increase at a decreasing rate, at some point they begin increasing at an increasing rate. ![]() You can see from the graph that once production starts, total costs and variable costs rise. The fixed costs are always shown as the vertical intercept of the total cost curve that is, they are the costs incurred when output is zero so there are no variable costs. The relationship between the quantity of output being produced and the cost of producing that output is shown graphically in the figure. As production increases, variable costs are added to fixed costs, and the total cost is the sum of the two. How Output Affects Total Costs At zero production, the fixed costs of $160 are still present. So, for example, with two barbers the total cost is: $160 + $160 = $320.įigure 7.3. Adding together the fixed costs in the third column and the variable costs in the fourth column produces the total costs in the fifth column. For example, two barbers cost: 2 × $80 = $160. These are calculated by taking the amount of labor hired and multiplying by the wage. The fourth column shows the variable costs at each level of output. The third column shows the fixed costs, which do not change regardless of the level of production. The first two columns of the table show the quantity of haircuts the barbershop can produce as it hires additional barbers. The variable costs are the costs of hiring barbers, which in our example is $80 per barber each day. The fixed costs of operating the barber shop, including the space and equipment, are $160 per day. The data for output and costs are shown in Table 7.2. Variable costs would also include raw materials.Īs a concrete example of fixed and variable costs, consider the barber shop called “The Clip Joint” shown in Figure 7.3. Labor is treated as a variable cost, since producing a greater quantity of a good or service typically requires more workers or more work hours. Variable costs, on the other hand, are incurred in the act of producing-the more you produce, the greater the variable cost. ![]() The level of fixed costs varies according to the specific line of business: for instance, manufacturing computer chips requires an expensive factory, but a local moving and hauling business can get by with almost no fixed costs at all if it rents trucks by the day when needed. ![]() Fixed costs can take many other forms: for example, the cost of machinery or equipment to produce the product, research and development costs to develop new products, even an expense like advertising to popularize a brand name. Once you sign the lease, the rent is the same regardless of how much you produce, at least until the lease runs out. One example is the rent on a factory or a retail space. Whether you produce a lot or a little, the fixed costs are the same. Fixed costs are expenditures that do not change regardless of the level of production, at least not in the short term.
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