Total cost encompasses all the expenses required to do a business. It is divided into two main categories – fixed cost and variable cost.
1. Fixed costs:
Fixed costs are those costs which do not vary with the level of output. Fixed costs represent the payments made for the use of fixed factors of production. Expenditure on advertisement is an example of fixed cost, because a shoe manufacturing company can increase quantity of production without increasing expenditure on advertisements.
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Other examples of fixed cost include costs incurred on account of fixed plant and equipment, rent charges etc.
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Total fixed cost (TFC) is the total cost of all the fixed inputs employed in a particular production process. If fixed cost is measured along the vertical axis and quantity of output is measured along the horizontal axis, TFC is represented by a horizontal straight line (see figure 9.1).
The diagrammatic representation of TFC reveals that when the output level is 5 units, TFC is Rs. 15. When output level increases to 10 units, TFC remains the same as Rs. 15. It also remains unchanged when 15 units of output are produced.
2. Variable costs:
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Variable costs are those costs which change directly with the change in output. Variable costs represent the payment made for the use of variable factors of production. Examples of variable costs are raw materials, labour charges, electricity charges, fuel charges etc., because if a shoe manufacturing company increases production of leather shoes, all these costs will surely increase.
Total variable cost represents the total cost of all the variable inputs employed in a particular production process. The slope of the total cost curve is related to returns to scale concept. We have already noted that returns to scale may be increasing, decreasing or constant. For increasing returns to scale, output increases more than in proportion to increases in input.
As a result, total cost increases less than in proportion to increase in output. This relationship is shown in panel (a) of figure 9.2. When returns to scale is decreasing, total cost increases at a steeper rate in comparison to rate of increase in output [panel (b) of figure 9.2], In case of constant returns to scale, total cost and output increase in the same proportion. This relationship is reflected in panel (c) in figure 9.2.
It is unlikely that a particular production function will exhibit the same degree of returns to scale over the entire range of output. Instead, it has been observed that in most cases returns to scale is increasing at low level of output, followed by constant returns to scale over intermediate level of output and finally decreasing returns to scale operates at high level of output.
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Hence, in the long run, total variable cost looks like the curve shown in panel (d) of figure 9.2.
Total cost is an aggregation of total fixed cost and total variable cost. The total cost curve is shaped exactly alike the total variable cost curve and it lies above the total variable cost curve. The distance between total variable cost curve and total cost curve represents total fixed cost (Figure 9.3).
