Types of Costs (DP IB Business Management)

An Introduction to Costs

• In preparing goods and services for sale, businesses incur a range of costs

  • Some examples of these these costs include purchasing raw materials, paying staff salaries and wages, and paying utility bills such as electricity  

• These costs can be broken into different categories

  • Fixed costs (FC) are costs that do not change as the level of output changes

    • These have to be paid whether the output is zero or 5000 

  • Variable costs (VC) are costs that vary directly with the output

    • These increase as output increases & vice versa

  • Total costs (TC) are the sum of the fixed + variable costs 

Comparison of the Types of Cost

Fixed costs (FC)

• The firm has to pay its fixed costs which do not change, irrespective if the output is 0 or 100,000 units

• The fixed costs for this firm are $4,000

Variable costs (VC)

• The variable costs initially rise proportionally with output, as shown in the diagram

• At some point, the firm will benefit from a purchasing economy of scale and the rise will no longer be proportional

Total costs (TC)

• The total cost is the sum of the variable and fixed costs

• The total costs cannot be 0 as all firms have some level of fixed costs

Direct & Indirect Costs

• Direct costs are related to the production of a particular product and vary directly with output

  • Examples include raw materials, components and packaging

• Indirect costs cannot be allocated easily to the production of a particular product

  • They relate to the business as a whole and are often called overheads

  • Examples include administration costs, salaries and rental fees

Diagram: direct and indirect Costs