classify and calculate costs using examples, e.g. fixed, variable, average and total

Costs are the money a business spends to produce goods or services. They can be grouped into different types that help managers decide how to price, budget and grow.

💡 Analogy: Think of a gym membership – you pay the same amount every month, whether you work out or not.

Fixed costs stay the same regardless of how many units you produce.

• Rent of factory or shop
• Insurance premiums
• Salary of permanent staff

Example: Rent of a shop is £500 per month.

💡 Analogy: Imagine buying pizza toppings – the more slices you make, the more cheese and pepperoni you need.

Variable costs change directly with the level of production.

• Raw materials per unit
• Direct labour per unit
• Utilities that vary with output

Example: Cost of raw material per unit is £3.

📈 Total cost is the sum of fixed and variable costs:

$$TC = FC + VC \times Q$$

where Q = quantity produced.

Example: If FC = £2000 and VC = £5 per unit, producing 400 units gives:

$$TC = 2000 + 5 \times 400 = 4000$$

📊 Average cost is the cost per unit:

$$AC = \frac{TC}{Q}$$

Using the previous example:

$$AC = \frac{4000}{400} = 10$$

So each unit costs £10 on average.

Exam Tip 📌

When a question asks you to calculate average cost, first find the total cost and then divide by the quantity produced. Remember: AC = TC ÷ Q.

For fixed and variable costs, look for clues: “per unit” indicates variable, while “per month” or “per year” indicates fixed.

Use the formulae in your notes to avoid calculation errors.

Quick Practice

Suppose a company has:

• Fixed cost: £3,000
• Variable cost per unit: £4
• Quantity produced: 250 units

Calculate:

1. Total Cost
2. Average Cost

Try it on your own before checking the answer below.

Answer:

$$TC = 3000 + 4 \times 250 = 3000 + 1000 = 4000$$

$$AC = \frac{4000}{250} = 16$$

Each unit costs £16 on average.