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One can decompose total costs as the sum of fixed costs and variable costs. Here output is measured along the horizontal axis. In the Cost-Volume-Profit Analysis model, total costs are linear in volume.
The total cost curve, if non-linear, can represent increasing and diminishing marginal returns.

In economics, total cost (TC) is the total economic cost of production and is made up of variable cost, which varies according to the quantity of a good produced and includes inputs such as labour and raw materials, plus fixed cost, which is independent of the quantity of a good produced and includes inputs that cannot be varied in the short term: fixed costs such as buildings and machinery, including sunk costs if any. Since cost is measured per unit of time, it is a flow variable.

Total cost in economics, unlike in cost accounting, includes the total opportunity cost (implicit cost) of each factor of production as part of its fixed or variable costs.

The rate at which total cost changes as the amount produced changes is called marginal cost. This is also known as the marginal unit variable cost.

If one assumes that the unit variable cost is constant, as in cost-volume-profit analysis developed and used in cost accounting, then total cost is linear in volume, and given by total cost = fixed cost + unit variable cost × amount of variable input used.

The total cost of producing a specific level of output is the cost of all the factors of input used. Often, economists use models with two inputs: physical capital, with quantity K; and labor, with quantity L. Capital is assumed to be the fixed input, meaning that the amount of capital used does not vary with the level of production in the short run. The rental price per unit of capital is denoted r. Thus, the total fixed cost equals Kr. Labor is the variable input, meaning that the amount of labor used varies with the level of output. In fact, in the short run, the only way to vary output is by varying the amount of the variable input. Labor usage is denoted L and the per unit cost, or wage rate, is denoted w, so the variable cost is Lw. Consequently, total cost is fixed cost (FC) plus variable cost (VC), or TC = FC + VC = Kr+Lw. In the long run, however, both capital usage and labor usage are variable.

Other economic models have the total variable cost curve (and therefore total cost curve) illustrate the concepts of increasing, and later diminishing, marginal returns.

In marketing, it is necessary to know how total costs divide between variable and fixed. "This distinction is crucial in forecasting the earnings generated by various changes in unit sales and thus the financial impact of proposed marketing campaigns."[citation needed] In a survey of nearly 200 senior marketing managers, 60% responded that they found the "variable and fixed costs" metric very useful.[1]

Calculating costEdit

  • Total product (= Output) = Q
  • Average Total Cost (ATC) = Total Cost / Q
  • Average Variable Cost (AVC) = Total Variable Cost / Q
  • Average Fixed Cost (AFC) = ATC – AVC
  • Total Cost (TC) = (AVC + AFC) × Q
  • Total Variable Cost (TVC) = AVC × Q
  • Total Fixed Cost (TFC) = TC – TVC
  • Marginal Cost (MC) = Change in Total Costs / Change in Q
  • Marginal Product (MP) = Change in Q / Change in Variable Factor
  • Marginal Revenue (MR) = Change in Total Revenue / Change in Q
  • Average Product (AP) = Q / Variable Factor
  • Total Revenue (TR) = Price × Q
  • Average Revenue (AR) = TR / Q
  • Total Product (Q) = AP × Variable Factor
  • Profit = TR – TC or (P-ATC)*Q
  • Loss = TC – TR (if positive)
  • Break Even Point: value of Q such that AR = ATC
  • Profit Maximizing Condition: MR = MC

See alsoEdit

ReferencesEdit

  1. ^ Farris, Paul W.; Neil T. Bendle; Phillip E. Pfeifer; David J. Reibstein (2010). Marketing Metrics: The Definitive Guide to Measuring Marketing Performance. Upper Saddle River, New Jersey: Pearson Education, Inc. ISBN 0-13-705829-2. The Marketing Accountability Standards Board (MASB) endorses the definitions, purposes, and constructs of classes of measures that appear in Marketing Metrics as part of its ongoing Common Language in Marketing Project.