To explain fixed and variable costs in more detail, we will make use of an example of a barbershop called Best Barber.
It is estimated that the total fixed cost, which includes the space and equipment, is R320 per day. The total variable cost is the cost of hiring barbers and is estimated at R160 per barber per day. This information is provided in the following table:
Total cost for Best Barber
| Labour
|
Quantity of haircuts
TP |
Total fixed costs
TFC (rand) |
Total variable cost
TVC (rand) |
Total cost
TC (rand) |
| 0 | 0 | 320 | 0 | 320 |
| 1 | 16 | 320 | 160 | 480 |
| 2 | 40 | 320 | 320 | 640 |
| 3 | 60 | 320 | 480 | 800 |
| 4 | 72 | 320 | 640 | 960 |
| 5 | 80 | 320 | 800 | 1 120 |
| 6 | 84 | 320 | 960 | 1 280 |
| 7 | 82 | 320 | 1 120 | 1 440 |
In the first column, the quantity of barbers employed is given, and in the second column, the quantity of haircuts (total product) the business produces per day.
Study the first two columns of the total cost table for Best Barber and answer the following questions:
By how much does the quantity of haircuts increase if the quantity of barbers increases from three to four?
- 24
- 20
- 12
- 8
- 4
It increases by 12. The marginal product of the fourth worker is therefore 12.
If you look closely at columns 1 and 2, you will see that as more barbers are employed, the quantity of haircuts increases.
Column 3 indicates the total fixed cost for the different quantities of haircuts (output). Of importance here about the total fixed cost is that it is the same, namely R320, for the different output levels.
The total fixed cost is the same for all levels of output because it involves _________.
- payments the firm must make in the short run regardless of its output level
- cost, which is under control of the management of the firm
The total fixed cost is in fact payments that do not vary with the level output, and one can say that it is not under the control, at least in the short run, of the management of the firm.
The fourth column indicates the total variable cost. Since labour is the only variable cost, the total variable costs for the different quantities of haircuts are calculated by multiplying the quantity of labour (barbers) by the wage paid. For example, three barbers would cost 3 × R160 = R480, and the variable cost associated with an output level of 60 haircuts is R480. This is entered in column 4.
If you look closely at column 4, you will notice that as the level of output (haircuts) increases, the total variable cost rises as well. This is because total variable cost is linked to the level of output, and the higher the level of output, the higher the total variable cost is.
What is the total variable cost associated with an output level of 60 haircuts? What is the total variable cost associated with an output level of 80 haircuts?
For 60 haircuts it is R480, and for 80 haircuts R800.
Total cost for Best Barber
| Labour
|
Quantity of haircuts
TP |
Total fixed costs
TFC (rand) |
Total variable cost
TVC (rand) |
Total cost
TC (rand) |
| 0 | 0 | 320 | 0 | 320 |
| 1 | 16 | 320 | 160 | 480 |
| 2 | 40 | 320 | 320 | 640 |
| 3 | 60 | 320 | 480 | 800 |
| 4 | 72 | 320 | 640 | 960 |
| 5 | 80 | 320 | 800 | 1 120 |
| 6 | 84 | 320 | 960 | 1 280 |
| 7 | 82 | 320 | 1 120 | 1 440 |
The fifth column indicates the total cost for the different output levels. The total cost is calculated by adding the fixed costs in the third column and the variable costs in the fourth column since:
Total cost = total fixed cost + total variable cost
TC = TFC + TVC
Therefore, for example, for an output level of 72 haircuts, the total cost would be R320 + R640 = R960.
Total cost for Best Barber
| Labour
|
Quantity of haircuts
TP |
Total fixed costs
TFC (rand) |
Total variable cost
TVC (rand) |
Total cost
TC (rand) |
| 0 | 0 | 320 | 0 | 320 |
| 1 | 16 | 320 | 160 | 480 |
| 2 | 40 | 320 | 320 | 640 |
| 3 | 60 | 320 | 480 | 800 |
| 4 | 72 | 320 | 640 | 960 |
| 5 | 80 | 320 | 800 | 1 120 |
| 6 | 84 | 320 | 960 | 1 280 |
| 7 | 82 | 320 | 1 120 | 1 440 |
If you look closely at column 5, you will notice that as the level of output (haircuts) increases, the total cost rises as well. This is because the total variable cost increases as more is produced. Notice that the total fixed cost does not change as the level of output increases.
Activity
Do the following activity to see if you understand the difference between total fixed and total variable costs:
The table below provides the cost data for Blaker Maker, a firm that manufactures garden ornaments. Fill in the missing values.
| Quantity of ornaments Q | Total fixed costs
TFC (rand)
|
Total variable cost
TVC (rand)
|
Total cost
TC (rand)
|
| 0 | |||
| 1 000 | 20 000 | 30 000 | 50 000 |
| 2 000 | 20 000 | 70 000 | |
| 3 000 | 20 000 | 65 000 | |
| 4 000 | 85 000 | 105 000 | |
| 5 000 | 20 000 | 110 00 | |
| 6 000 | 150 00 | 170 000 | |
| 7 000 | 20 000 | 230 000 |
| Quantity of ornaments Q | Total fixed costs
TFC (rand)
|
Total variable cost
TVC (rand)
|
Total cost
TC (rand)
|
| 0 | 20 000 | 0 | 20 000 |
| 1 000 | 20 000 | 30 000 | 50 000 |
| 2 000 | 20 000 | 50 000 | 70 000 |
| 3 000 | 20 000 | 65 000 | 85 000 |
| 4 000 | 20 000 | 85 000 | 105 000 |
| 5 000 | 20 000 | 110 00 | 130 000 |
| 6 000 | 20 000 | 150 00 | 170 000 |
| 7 000 | 20 000 | 210 00 | 230 000 |
Note that the fixed cost of R20 000 stays the same for all levels of output, including an output level of zero. At an output level of zero, however, the variable cost is zero and the total cost is therefore R20 000.
Total cost (TC) = fixed cost (FC) + variable cost (VC). At an output level of 3 000, total cost is therefore R20 000 + R65 000 = R85 000.
Variable cost (VC) = total cost (TC) – fixed cost (FC). At an output level of 20 000, the variable cost is therefore R70 000 – R20 000 = R50 000.