At a Glance
Fixed & Variable Costs
Every firm pays some costs that never change (rent, salaries) and others that rise with production (raw materials, wages).
Cost Calculations
From these two cost types, we can calculate total costs, average costs per unit, and see how efficiency changes as output grows.
Revenue
Revenue is the money firms earn from sales. It depends on both price and quantity sold.
Firm Objectives
Firms don't all want the same thing. Some maximize profit, others prioritize growth, survival, or social good.
Costs & Revenue
The Two Types of Costs Every Firm Pays
When a business produces goods or services, it faces a range of expenses. The brilliant thing about economics is that these costs fall into just two categories—and once you understand that split, everything else clicks into place.
1. Fixed Costs (FC)
These are costs that do not change no matter how much (or how little) the firm produces. If output is zero or 10,000 units, these costs stay the same.
- Building rent — you pay it whether the factory is running full capacity or idle
- Management salaries — your senior staff need paying, regardless of output
- Insurance — the building and equipment need coverage every month
- Bank loan repayments — contractual obligation, independent of sales
💡 Think of it this way: Fixed costs are what you pay just to keep the doors open. They're like the rent on your bedroom — whether you spend 1 hour or 24 hours there, you still owe the money.
2. Variable Costs (VC)
These costs vary directly with output. As production increases, variable costs rise proportionally. Cut production, and they fall.
- Raw materials — need 1000 units? Buy more leather, steel, or fabric
- Wages of production workers — more output = more workers or longer shifts
- Packaging — each unit sold needs a box and label
- Fuel/electricity — running machinery costs more when you run it longer
🎯 Key insight: Variable costs per unit (AVC) often stay constant even as total variable costs rise. If it costs $60 to make one shoe, it costs $120 for two shoes. The total went up, but the per-unit cost stayed the same—at least initially.
3. Total Costs (TC)
This is simply the sum of everything the firm must pay:
The total cost curve never starts at zero because the firm always has at least some fixed costs to cover, even if it makes nothing.
How to Calculate Different Types of Costs
Once you know total costs, you can break them down further into average costs—which is how much each unit costs on average. This is crucial because it shows you how efficient the firm is being.
Why do we need all these averages?
📌 Worked Example: Calculating All the Costs
Setup:
| Output (Q) |
TFC |
TVC = $60 × Q |
TC = TFC + TVC |
AFC = TFC ÷ Q |
AVC = TVC ÷ Q |
AC = TC ÷ Q |
|---|
| 0 |
$200 |
— |
$200 |
— |
— |
— |
| 1 |
$200 |
$60 |
$260 |
| 2 |
| 5 |