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
- advertising
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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