Cost Concepts – Fixed, Variable, Total, Marginal & Average Cost

Cost analysis is essential for pricing, output and profit decisions.

1. Fixed Cost (FC)

Fixed costs are costs which do not change with output in the short run.

Examples:

• Rent of factory building
• Salaries of permanent staff
• Insurance, licence fees

Even if output is zero, fixed costs must be paid.

2. Variable Cost (VC)

Variable costs vary directly with level of output.

Examples:

• Raw materials
• Power, fuel
• Wages of casual labour

If output is zero, variable cost is also zero.

3. Total Cost (TC)

Total Cost = Fixed Cost + Variable Cost

TC = FC + VC

4. Average and Marginal Cost

(a) Average Cost (AC)

Average Cost = Total Cost / Output

AC = TC / Q

It can be broken as:

• Average Fixed Cost (AFC) = FC / Q
• Average Variable Cost (AVC) = VC / Q

And:

AC = AFC + AVC

(b) Marginal Cost (MC)

Marginal Cost is addition to total cost when one more unit of output is produced.

MC = ΔTC / ΔQ

5. Numerical Illustration

Suppose a firm has FC = ₹100.

6. Behaviour of Cost Curves (Conceptual)

• FC is constant; AFC falls as output increases.
• VC rises with output; AVC is generally U-shaped.
• AC is also U-shaped because AFC falls and AVC first falls then rises.
• MC initially falls, then rises; it cuts AC and AVC at their minimum points.

7. Quick Revision Points

• FC constant; VC varies with output; TC = FC + VC.
• AC = TC/Q; MC = ΔTC/ΔQ.
• AFC falls with output; AVC and AC are U-shaped.
• MC intersects AVC and AC at their minimum.

8. Quiz Time 🎯