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By the end of this topic, you should be able to:
When a firm produces goods or services, it has to spend money on the things it needs — such as workers, raw materials, buildings, and equipment. These spending amounts are called costs of production — the money a firm spends in order to produce its output.
Costs are split into different types depending on whether they change when the firm produces more or less.
Fixed costs are costs that stay the same no matter how much (or how little) a firm produces. Even if the firm produces zero units, it still has to pay these costs.
Think of it this way: even if a bakery bakes zero loaves one day, it still has to pay its rent and its manager's salary.
Examples of fixed costs:
On a graph: Fixed cost appears as a horizontal straight line — it does not go up or down as output changes.
Cost ($)
|
|____________________________ ← Fixed Cost (e.g. $4,000)
|
+----------------------------→ Output
Variable costs are costs that change directly with output. When a firm produces more, variable costs go up. When it produces less, they go down. If a firm produces nothing, variable costs are zero.
Example: If a factory makes more shirts, it needs more fabric and more workers' hours — both of these are variable costs.
Examples of variable costs:
On a graph: Variable cost starts at zero and slopes upward as output increases.
Cost ($)
| /
| /
| / ← Variable Cost
| /
| /
| /
| /
| /
+----------------------------→ Output
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