Fixed & Variable Costs (Edexcel A-Level Economics 3.3.2)

Fixed Costs

  • Expenses that remain constant in the short run; independent of output or sales volume
  • Must be paid even when Q=0Q = 0 (e.g. during shutdown)
  • Also called “overheads”
  • High fixed costs ⇒ higher output required to break even
  • Common examples:
    • Rent / leasing charges
    • Insurance premiums
    • Salaried staff (fixed portion)
    • Marketing budget commitments
    • Consulting & research fees
    • Depreciation on capital equipment

Variable Costs

  • Expenses that rise or fall directly with production or sales volume
  • Total variable cost (TVC) increases as QQ rises; falls when QQ falls
  • Average variable cost: AVC=TVCQAVC = \frac{TVC}{Q}
  • Determined by marginal cost of each extra unit
  • Typical examples:
    • Raw materials & components
    • Energy / fuel used in production
    • Packaging & shipping
    • Commission-based wages, part-time labour
    • Warranty repair outlays

Cost Curves & Relationships

  • Total fixed cost (TFC) curve: horizontal line; e.g. TFC=£500TFC = £500 for all output levels
  • Average fixed cost (AFC): AFC=TFCQAFC = \frac{TFC}{Q} ⇒ falls continuously as output rises
    • Example with TFC=£500TFC = £500
    • Q=1Q = 1 → AFC=£500AFC = £500
    • Q=2Q = 2 → AFC=£250AFC = £250
    • Q=5Q = 5 → AFC=£100AFC = £100
  • Because TFC is unchanged, spreading it over more units lowers per-unit cost – key to competitiveness

Strategic Implications for Firms

  • Start-ups & challengers aim to scale quickly to reduce AFCAFC and overall average cost
  • Lean production strategies: keep fixed costs minimal (e.g. rent equipment, use short-term contracts) to lower break-even output
  • Economies of scale (technological improvements, government incentives) can cut both fixed and variable costs, as seen in the heat-pump market