Total costs are defined as those costs realised by a business which are created as a result of supplying a good or service. These costs are usually split between variable and fixed costs. Variable costs change with increases and decreases in production output whereas fixed costs remain the same. You can calculate both fixed and variable costs with the production costs equation.
- Skill level:
- Moderately Easy
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Review the formula for total costs:
Total Production Costs (TPC) = Total Fixed Costs (TFC) + Total Variables Cost (TVC).
Determine and summarise all fixed costs. Fixed costs relate to those factors of production that do not change and/or are not affected by changes in levels of production in the short run. Examples include building rents ($1,000), capital leases ($2,000), certain utilities ($500), administrative or indirect labour ($1,000), interest expense on loans ($200), depreciation expense ($800), and business insurance ($1,000). These costs are easier to calculate as they tend to stay the same over time and can therefore be determined using an average. Summing all costs together equals £4,225.
Determine total production costs. These are the total costs for the production period. The period can be one month, one quarter or one year. Let's say total production costs are £6,500.
Calculate the value of variable costs. Variable costs are ubiquitous by nature. This is because they vary with changes in output. Examples include raw materials, direct labour, component parts and the costs of electricity and gas. These are all expenses that rise and fall with the level of production in the short term. The calculation is: Total Production Costs (£6,500) = Total Fixed Costs (£4,225) + Total Variables Cost (TVC). Working through the equation, TVC equals $10,000 - $6,500 or £2,275.
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