Fixed, variable and total costs

Fixed costs do not change when the level of output changes. They stay the same whether output is 10 units or 10,000, and must be paid even if output falls to zero. A cinema paying a £2,400 yearly licence fee to show films pays the same in a quiet January as in a busy August. Business rates and the salary of a supervisor on a fixed contract are also fixed costs.

Variable costs change as output changes. They rise as more is produced and fall when production slows, because they are the costs of the things used up making each unit, such as fruit, bottles and labels for each smoothie, or staff paid for each item they produce. With no output, variable costs are zero: no smoothies blended means no fruit bought. To find total variable costs, multiply the variable cost of one unit by the quantity produced:

• Total variable costs = variable cost per unit × quantity of output

For example, a smoothie maker spends £0.80 on fruit and a bottle for each drink. Making 2,000 bottles gives total variable costs of 2,000 × £0.80 = £1,600. At 3,000 bottles the figure is £2,400, so the cost moves with output — that is what makes it variable.

Working out total costs

Total costs are the whole amount a business pays out over a period: its fixed costs plus its variable costs, so TC = TFC + TVC.

Suppose the smoothie maker has fixed costs of £5,000 a month and produces 2,000 bottles. Total variable costs are £1,600, so total costs are £5,000 + £1,600 = £6,600. At 4,000 bottles, fixed costs stay at £5,000 but variable costs rise to £3,200, giving total costs of £8,200. Even with no production, total costs equal the fixed costs, so they never fall to zero.

A cost is fixed or variable because of how it behaves when output changes, not because of what it is called: a delivery driver paid per parcel is a variable cost, while one on a yearly salary is fixed.