Total Cost Equation

Introductionn

Businesses have two types of costs: fixed costs and variable costs.
Fixed costs remain the same whether we sell (or produce) zero or any number of units.
Examples of fixed costs are:

plant and machinery
product design and development costs
managerial salaries
rents

Unit Variable Costs (Variable costs per unit) are the costs to sell or produce one unit of a product. They stay the same per unit.
They change in total amount: as the number of units decreases the total decreases or as the number of units increases the total increases.
Examples of variable costs per unit are:

direct material costs
direct labor costs
sales commissions

To calculate the total variable costs, we multiply the variable costs per unit (unit variable costs, VC) by the number of units sold or produced.
Total Variable Costs = Unit Variable Costs × Number of Units; TVC = VC × Q
The total costs are the sum of the total variable costs and fixed costs:
Total Costs = Total Variable Costs + Fixed Costs; TC = TVC + FC

Examples

(1)A local flash memory company makes 1100 USB sticks. Fixed costs (FC) are $9198 and the unit variable costs are $10.50.
Question: How much are the total costs?
Solution:
Using the formula: TVC = VC × Q = 10.50 × 1100 = $11,550
Using the formula: TC = TVC + FC = 11500 + 9198 = $20748
The total costs are $20748.

(2) A local bookstore in Boston sells 10000 books a month. Fixed costs (FC) for the same period are $15000 and the unit variable costs are $0.50.
Question: How much are the total costs?
Solution:
Using the formula: TVC = VC × Q = 0.50 × 10000 = $5000
Using the formula: TC = TVC + FC = 5000 + 15000 = $20000
The total costs are $20000.

Please access the following link to do an additional exercise on total cost equation:
Exercise on total cost equation

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Date of last modification: March 19, 2019