FIXED VS. VARIABLE COSTS

To know the types of costs businesses incur and how they deal with them.

Why products are priced the way they are from the business’s perspective (as opposed to the consumer’s).

WHY LEARN THIS?

Variable Costs: Costs that VARY with production or activity.

Examples: hourly wages, electricity, hot dog and hamburger buns.

Fixed Costs: Costs that are incurred no matter how much is produced.

Examples: rent, salaries

(Switch to Excel Spreadsheet)

DEFINITIONS

y = m(x) + b (Total Cost) (variable cost * (# of units (Fixed Cost) per unit) produced) [rent, salary]

Variable Cost

EQUATION

m(x) = variable costb = fixed costy = total cost

Cost of a Samsung S5: $260 Cost of factory rent (fixed cost): $10,000

Y = $260x+ $10,000

Total Cost at: 0 phones = $10,000 (260(0) = 0+10,000 = 10,000) 100 phones = $36,000 (26,000 + 10,000)

200 phones = $? 300 phones = $?

GUIDED PRACTICE

Phones Made Total Cost

0 $10,000

100 $36,000

200 $62,000

300 $88,000

GRAPH

Total Cost

Phones Made

Differentiating Fixed and Variable costs allow managers to know which costs are DIRECTLY related to production and/or distribution and which are not.

Most fixed costs are called “overhead” in the business world.

Allows managers to make better business decisions because…

Managers have direct control over certain costs but not over others.

IMPORTANCE

Knowing fixed costs and variable costs allows a company to calculate its break-even point (the point where a company covers

all off its costs to incur zero profits).

Sales – Total Variable Costs = Contribution Margin

More to come on break-even and Contribution Margin in the Business Unit.

IMPORTANCE