Variable Costs
What is Variable Costs?
Variable Costs are costs that change directly with the level of output in the short run.
These include expenses like wages for hourly workers, raw materials, and utilities that increase as more output is produced and fall when output decreases.
Variable Costs: a worked example
A screen printing shop pays $4 for each blank shirt and $1 of ink per shirt, and pays $18 an hour to a printer who finishes 30 shirts an hour, so labor costs $18 / 30 = $0.60 per shirt. Average variable cost is $4 + $1 + $0.60 = $5.60, a figure that holds only while the press keeps that same pace. Printing 300 shirts gives total variable cost of 300 x $5.60 = $1,680. The shop also owes $900 a month in rent and equipment leases, which do not move with output, so total cost is $1,680 + $900 = $2,580. Raise output to 450 shirts and variable cost climbs to 450 x $5.60 = $2,520 while the $900 stays put, so total cost is $3,420. Variable cost rose by a full 50 percent alongside output while total cost rose by only about 33 percent.
The mistake students make with variable costs
The usual error is sorting costs by how the bill arrives rather than by whether the cost moves with output. A monthly electricity bill changes size each month, so students file it as variable even when most of it lights an empty shop, while a salaried supervisor gets filed as fixed even when the shop only hires a second supervisor after output doubles. Apply one test: if quantity produced fell to zero tomorrow, would this payment fall too? Also remember the split exists only in the short run. Given enough time a firm can end the lease and sell the presses, so in the long run every cost is variable.
Variable Costs questions
Is rent a fixed cost or a variable cost?
Rent locked in by a lease is a fixed cost in the short run, because the payment is the same whether the firm produces nothing or runs flat out. The exception students meet is rent that scales with activity, such as a stall fee charged per unit sold, which behaves as a variable cost. Over the long run even a lease expires and the firm can move to a smaller or larger space, so rent becomes variable once every input can be adjusted.
How do you calculate average variable cost?
Divide total variable cost by quantity. A shop carrying $1,680 of variable cost at 300 shirts has an average variable cost of $1,680 / 300 = $5.60. You can also reach it by subtracting average fixed cost from average total cost, since ATC = AFC + AVC. AVC earns its keep on the exam because the shutdown rule compares price with minimum AVC: a firm losing money still produces in the short run as long as price covers average variable cost.
Why do variable costs eventually rise faster than output?
Diminishing marginal returns drive the acceleration. As a firm adds workers to a fixed stock of machines, each extra worker adds less output than the one before, so buying the next unit of output takes more labor hours than the last one did. If the tenth worker adds 8 shirts and the eleventh adds only 5, the same hourly wage now buys fewer shirts, which pushes marginal cost and then average variable cost upward.
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