🧱 Fixed Costs
Definition: Fixed costs are costs that do not change with the level of output or sales. They stay the same whether the business produces 1 unit or 10,000 units.
- Rent for premises
- Insurance premiums
- Salaries of permanent staff
- Loan repayments
- Depreciation of equipment
Fixed costs are sometimes called 'overheads' — they have to be paid even if the business sells nothing! 🏢
📈 Variable Costs
Definition: Variable costs are costs that change in direct proportion to the level of output or sales. Produce more → costs go up. Produce less → costs go down.
- Raw materials and components
- Packaging materials
- Direct labour (piece-rate workers)
- Delivery and distribution costs
- Sales commissions
Example: A pizza restaurant's flour, cheese and toppings are variable costs — the more pizzas it makes, the more ingredients it uses 🍕
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➕ Total Costs & Semi-Variable Costs
Total costs
Formula: Total costs (TC) = Fixed costs (FC) + Variable costs (VC)
This is one of the most fundamental formulas in business — it tells you the complete cost of running the business at a given level of output.
Semi-variable costs
Some costs have both a fixed and a variable element. These are called semi-variable (or mixed) costs.
- Phone bills — fixed monthly charge + variable call charges
- Electricity — standing charge + cost per unit used
- Sales staff pay — base salary (fixed) + commission (variable)
Semi-variable costs sit between fixed and variable — they have a BASE cost that stays constant plus an extra part that changes with output 📊
📏 Average Cost per Unit
Formula: Average cost = Total costs ÷ Number of units produced
Average cost tells you how much each unit costs to produce. As output increases, fixed costs are spread over more units — so the average cost per unit typically falls.
Example: A business has fixed costs of $10,000 and variable cost per unit of $5. If it makes 1,000 units: TC = $10,000 + (1,000 × $5) = $15,000. Average cost = $15,000 ÷ 1,000 = $15 per unit. If it makes 2,000 units: TC = $10,000 + (2,000 × $5) = $20,000. Average cost = $20,000 ÷ 2,000 = $10 per unit.
This is why larger businesses often have lower costs per unit — they benefit from economies of scale! 📉
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🏷️ Classifying Costs in Practice
In the exam, you may be given a list of costs and asked to classify them. Use this simple test:
- Does the cost change when output changes? YES → Variable | NO → Fixed
- Does it have both a fixed part and a changing part? → Semi-variable
- Is the cost directly linked to each unit produced? → Variable
- Would you still pay it if you produced zero units? → Fixed
The zero-output test is your best friend: if the cost is still there when the factory is empty — it's FIXED! 🏭