variable cost

Examples of variable cost in the following topics:

• Types of Costs

  • It consists of variable costs and fixed costs.
  • Total cost is the total opportunity cost of each factor of production as part of its fixed or variable costs .
  • In the long run, the cost of all inputs is variable.
  • Economic cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity costs.
  • This graphs shows the relationship between fixed cost and variable cost.

• Shut Down Case

  • If a firm decreased production it would still acquire variable costs not covered by revenue as well as fixed costs (costs inevitably incurred).
  • When determining whether to shutdown a firm has to compare the total revenue to the total variable costs.
  • If the revenue the firm is making is greater than the variable cost (R>VC) then the firm is covering it's variable costs and there is additional revenue to partially or entirely cover the fixed costs.
  • A firm that exits an industry does not earn any revenue, but is also does not incur fixed or variable costs.
  • Firms will produce as long as marginal revenue (MR) is greater than average total cost (ATC), even if it is less than the variable, or marginal cost (MC)

• Costs and Production in the Short-Run

  • Often the producer will know the costs at a few levels of output and must estimate or calculate the production function in order to make decisions about how many units of the variable input to use or altering the size of the plant (fixed input).
  • Variable Cost (VC) is the quantity of the variable input times the price of the variable input.
  • Sometimes VC is called total variable cost (TVC).
  • Average Variable Cost (AVC) is the VC divided by the output, AVC = VC/Q.
  • It is the variable cost per Q.

• Economic Costs

  • Total cost (TC): total cost equals total fixed cost plus total variable costs (TC = TFC + TVC) .
  • Variable cost (VC): the cost paid to the variable input.
  • Variable input is traditionally assumed to be labor.
  • Average variable cost (AVC): variable costs divided by output (AVC = TVC/q).
  • The average variable cost curve is normally U-shaped.

• Graphical Representations of Production and Cost Relationships

  • The short-run, total product function and the price of the variable input(s) determine the variable cost (VC or TVC) function.
  • Since the VC (total variable cost) is the price of labour times the quantity of labour used (LPL), VC will increase at a decreasing rate.
  • Variable cost (VC) will increase at an increasing rate (MC will be rising).
  • The total variable cost is determined by the price of the variable input and the TP function.
  • The average variable cost is simply the variable cost per unit of output (TP or Q):

• Short Run Firm Production Decision

  • However, variable costs and revenues affect short run profits.
  • Continue producing if average variable cost is less than price per unit.
  • Shut down if average variable cost is greater than price at each level of output.
  • Revenue would not cover the variable costs associated with production.
  • By exiting the industry, the firm earns no revenue but incurs no fixed or variable costs.

• Short Run and Long Run Costs

  • Long run costs have no fixed factors of production, while short run costs have fixed factors and variables that impact production.
  • Fixed costs have no impact of short run costs, only variable costs and revenues affect the short run production.
  • Variable costs change with the output.
  • Examples of variable costs include employee wages and costs of raw materials.
  • The short run costs increase or decrease based on variable cost as well as the rate of production.

• Production Outputs

  • Variable costs are only those expenses that are directly tied to the production of more units; fixed costs are not included.
  • Loss-minimizing condition: The firm's product price is between the average total cost and the average variable cost.
  • Shutdown: The price is below average variable cost at the profit-maximizing output.
  • The revenue gained from sales of these products do not offset variable and fixed costs.
  • If it does not produce goods, the firm suffers a loss due to fixed costs, but it does not incur any variable costs.

• Average and Marginal Cost

  • Marginal cost is the change in total cost when another unit is produced; average cost is the total cost divided by the number of goods produced.
  • Marginal cost is not related to fixed costs.
  • It is also equal to the sum of average variable costs and average fixed costs.
  • When the average cost declines, the marginal cost is less than the average cost.
  • When the average cost increases, the marginal cost is greater than the average cost.

• The Supply Curve in Perfect Competition

  • The total revenue-total cost perspective and the marginal revenue-marginal cost perspective are used to find profit maximizing quantities.
  • In economics, a cost curve is a graph that shows the costs of production as a function of total quantity produced.
  • In a free market economy, firms use cost curves to find the optimal point of production (minimizing cost).
  • There are two ways in which cost curves can be used to find profit maximizing quantities: the total revenue-total cost perspective and the marginal revenue-marginal cost perspective.
  • Supply curves are used to show an estimation of variables within a market economy, one of which is the general price level of the product.