Question

Explain situation where fixed cost becomes variable cost.

In details please with examples.

Answer 1

ANSWER-

Variable Costs-

Variable cost (VC) changes according to the quantity of a good or service being produced. It includes inputs like labor and raw materials. Variable costs are also the sum of marginal costs over all of the units produced (referred to as normal costs). For example, in the case of a clothing manufacturer, the variable costs would be the cost of the direct material (cloth) and the direct labor. The amount of materials and labor that is needed for each shirt increases in direct proportion to the number of shirts produced. The cost “varies” according to production.

Fixed Costs-

Fixed costs (FC) are incurred independent of the quality of goods or services produced. They include inputs (capital) that cannot be adjusted in the short term, such as buildings and machinery. Fixed costs (also referred to as overhead costs) tend to be time related costs, including salaries or monthly rental fees. An example of a fixed cost would be the cost of renting a warehouse for a specific lease period. However, fixed costs are not permanent. They are only fixed in relation to the quantity of production for a certain time period. In the long run, the cost of all inputs is variable.

The long run is defined as a period in which all INPUTS are variable. Because of that all costs are variable too.

To understand this, we need to understand the difference between the long run and short run. Economists use the short to describe a situation where some factors of production cannot be changed. Whereas the long-run describes the situation where all factors of production can be changed. Factors of production include labour (workers) and capital (machines, factory size, etc.). A good example of a fixed cost is the factory building. In the short run the size of the factor building is a fixed size. It takes a long time to change the factory because you have to buy the land, get planning permission, etc.. Because of this there is a maximum number of machines that can be used. The fixed cost in this example is the cost to build the factory. Therefore, the fixed cost cannot change in the short run. In the long run you can change the factory size by definition of the long run. You can sell parts of it to other businesses, decreasing your costs. Or you could increase the factory size, which increases your costs.

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