What this lesson teaches
I can explain a firm's cost and revenue concepts in the short run and the long run.
Syllabus 9570, 2.2.2(a). Cost and Revenue: Firms' cost and revenue concepts in the short run and long run
Make a guess
A bakery makes zero loaves during a two-week renovation. Which of its costs still have to be paid?
- Flour and electricity for the ovens.
- Fixed costs such as rent and loan repayments.
- No costs, because a bakery that makes nothing spends nothing.
Show the answer
Fixed costs such as rent and loan repayments.
Fixed costs do not depend on output. Even at zero output, the lease and loans must still be paid.
Fixed costs do not change with output; variable costs do; total cost is the two added together.
Total fixed cost (TFC) does not change with output in the short run. Rent, loan repayments and insurance must be paid even if the firm produces nothing.
Total variable cost (TVC) rises with output. Ingredients, electricity for machines and hourly wages are examples.
Total cost (TC) = TFC + TVC.
In Singapore, high rents make fixed costs especially heavy for small firms, while rising wages push up variable costs.
- TFC
- Does not change with output: rent, insurance.
- TVC
- Rises with output: materials, hourly wages.
- TC
- TFC + TVC.
Worked example: A workshop's weekly costs
A workshop pays an $18 fixed weekly charge. Its variable costs for 0 to 5 batches are $0, $10, $24, $42, $66 and $96.
- At 0 batches: TC = $18 + $0 = $18. The firm still pays the fixed charge.
- At 3 batches: TC = $18 + $42 = $60.
- At 5 batches: TC = $18 + $96 = $114.
- Fixed cost stays at $18; only variable cost rises.
Watch out for this
Fixed costs are costs that never change.
Fixed costs do not change with output in the short run. The rent can still go up when the lease is renewed.
Check your understanding
Which is a variable cost for a bubble tea shop?
- Tea leaves and tapioca pearls.
- Insurance for the premises, which is paid every month.
- The monthly rent, which the shop pays out of each month's sales.
Show the answer
Tea leaves and tapioca pearls.
Right. The more drinks it sells, the more of these it uses.