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Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.
All business costs can be classified as either variable costs or fixed costs. Fixed costs are those costs that do not change based on production levels, while variable costs increase or decrease based on production.
Fixed costs can be assets like buildings and equipment. For example, a beverage company that bottles water is going to need a physical building and an assembly line that includes specialized equipment. If we assume the building and equipment are leased, there is a monthly payment for each of them. The company is responsible for paying 100% of the monthly payments, whether they produce one case of bottled water or 10,000 cases of bottled water.
It is important to note that fixed costs are not always the same. Like the price of anything, they can change - sometimes unpredictably and sometimes on a regular schedule, but they do so based on some other factor, not the level of production. For example, if a lease contract is being renegotiated and a $10,000 per month lease payment is increased to $10,500 per month, fixed costs have risen, but not because of production levels.
As mentioned above, fixed costs are one part of the total cost formula. The formula used to calculate costs is FC + VC(Q) = TC, where FC is fixed costs, VC is variable costs, Q is quantity, and TC is total cost.
It is important to understand that variable costs, as opposed to fixed costs, are those costs that change based on the amount of product being produced. For example, our bottled water company has a variable cost in bottles. The more bottled water they produce, the higher their cost associated with bottles will be.
If we return to our bottled water company and say that the monthly lease for their building is $10,000 and the monthly lease for the equipment is $15,000, then our total fixed costs are $25,000. If the cost of labels, bottles, packaging, and water that go into each case of bottled water is two dollars, then our variable costs are two dollars. At this point, we have our cost structure as $25,000 + $2(Q) = TC.
Now, each month, total costs can be calculated by plugging actual quantity produced into the cost function, which gives us $25,000 + $2(30,000) = TC. We can then get our total costs (TC) by doing the math: $25,000 + $2(30,000) = $85,000.
With this information, per unit total costs can be calculated by dividing the quantity produced into the total cost. Based on our sample month above, per unit total costs would be $85,000 / 30,000 = $2.833.
The implications of fixed costs will become clearer when you've learned about overhead costs, variable costs and the total cost formula. For the purposes of this lesson, the important thing to remember is simply fixed costs are costs that do not change based on production, such as assets like buildings and equipment.
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Introduction to Business: Homework Help Resource25 chapters | 509 lessons | 1 flashcard set
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