Question

The following are costs incurred by a shoe manufacturer. Determine and explain whether each one is a fixed cost or a variable cost or has some element of both.

(a) The cost of leather.

(b) The fee paid to an advertising agency.

(c) Wear and tear on machinery.

(e) Electricity for heating and lighting.

(f) Electricity for running the machines. (

g) Basic minimum wages agreed with the union.

(h) Overtime pay.

Answer 1

Fixed costs are those costs that are incurred irrespective of production of goods and services. For a firm, Fixed cost is always constant and is never zero. On the other hand, variable costs vary directly with the level of production. Higher the production and output, higher will be the variable cost as variable costs depend on the level of output / production. Also, Variable costs are zero when there is no production.

Now, coming to the shoe manufacturer the following are his/her fixed/ variable/ element of both :

(a) Cost of leather - Variable Cost

Cost incurred for acquiring leather is a variable cost to a shoe manufacturer as it is a raw material in the process of producing shoes. When production is zero, no raw material is purchased by the firm, thus making it a type of variable cost.

(b) Fees to Advertising Agency - Variable Cost

Advertising is done to sell of finished goods from the manufacturer to the final consumer. When production is zero , the firm has no output to sell and thereby would not spend on advertisement. On the other hand, to increase sales volume of the increase quantity of final goods produced , a firm is likely to spend more on advertisement.

(c) Wear and tear on machinery - an element of both

Wear and tear on machinery is written as depreciation in the books of a firm. Calculating depreciation depends on the methods adopted by the firm. When depreciation is calculated for a machine upon the number of units produced or number of machine hours worked then it is variable. But if it is calculated upon the straight line method (SLM) irrespective of production, then it is fixed.

(d) Electricity for heating and lighting - Variable Cost

Heating, lighting etc are essential processes that are required in the process of production. Also they are subjected to incur their own costs in the form of Electricity charges. Thus electricity charges directly depend on the level of production and is a variable cost.

(e) Electricity of running machines - Variable costs

All machines that are involved in the process of production, consumer fuel or electricity in order to run and function properly. Machines only function when production process and output is generated. Thus when production is zero, machines are not used and there wouldn't be any electricity charges for running the machines. Thus electricity for running machines is a variable cost.

(d) Basic minimum wages agreed with the union - Fixed cost  

Minimum wages are fixed on an hourly basis that rewards a worker for his / her efforts put into the work. These workers (Salaried Labor) are to be paid irrespective of level of output. This thus makes minimum fixed wages a type of fixed cost.

Yet this depends on whether the labor is a salaried labor or a casual labor. When it comes to casual labor, their wages depend on the production activity of the firm. If the firm does not produce any output, then they aren't hired to help out in the factory. Casual labor earn daily wages for their work done in a day, and if a firm does not produce for a day, then they are not paid.

(e) Overtime Pay - Variable cost

Overtime work is done by workers who work past their scheduled time, inputting their efforts in the process of production. In order to reward them for their extra efforts in production, the firm pays them an overtime pay. If there is no production, there is no possibility of overtime work and overtime pay. Thus overtime pay depends on the level of output and is a type of variable cost.