Question

What are Ford Motor Company's fixed and variable costs? Provide 1-2 examples discussing how an increase in variable costs would affect fixed cost amounts

Answer 1

First we need to understand the concept of fixed cost and variable costs. Explaining in simple terms fixed costs are the costs which need to be incurred irrespective of the volume of production and will be incuured even if the production volume is zero, while variable costs are the costs which increase or decrease with an increase or decrease in production volume and will be zero where the production volume is zero.

Ford motor company is an automobile company which has set up plants across to manufacture their products. Now the fixed costs which Ford company incurs are: Rent for factory or office premises, Salary and wages of its fixed staffs, Depreciation expenses on machines acquired, Interest costs on Long term loans, insurance expenses, rates and taxes, AMC costs of maintenance, etc. All of these costs incurred are fixed in nature and amount of expenses is fixed irrespective of the volume of production. Certain examples of variable costs which Ford company would incur are: Raw material costs, power consumption in factory, factory wages, etc.

Examples of impact of increase in variable costs impacting fixed costs amounts:

Example 1: An increase in variable costs will not impact the fixed cost, where the increase in variable cost is as a result of increase per unit cost. For example, the price of a particular raw material rise by $1 which is consumed @1000 units for a given quantum of production. The company would now be paying $1 per unit more for the same quantity of production now i.e. $1000 in total, however other fixed costs like salary, depreciation, etc. remain unaffected as a result of this change.

Example 2: An increase in variable costs will not impact the fixed cost, where the increase in variable cost is as a result of increase in volume of production. For example, the price of a particular raw material is $5 and 1000 units of raw material is required for 100 units of production i.e. total cost if $5000. Now, say the production volume increases to 120 units due to increased demand, then 1200 units of that particular raw material will be required @$5 increasing the variable cost to $6000. This increase in variable costs as a result of volume of production will have no impact on other fixed cost amounts like depreciation, salaries, etc.

Example 3: Generally variable costs and fixed costs are independent of each other and an increase or decrease in one does not impact the other. However, in certain situations it may have an impact. For example the company is planning to deploy a machine on rent per unit produced which was earlier deployed on fixed rent, then such an arrangement will increase the variable costs (rent will be paid @ per unit produced) but will decrease the fixed costs (fixed rent paid earlier need not be paid now).