Variable costs are costs that vary with output (quantity produced in a period), thus as output increases, variable costs also increase.
They are costs incurred in acquiring variable factors of production, e.g. raw materials, petrol, stationary, etc.; That is, they fluctuate (increase or decrease) with quantity of goods produced in the factory. The greater the variable costs, the higher the production output, and vice versa. They are only incurred when goods are being produced. Their expenses are not incurred if the factory is temporarily closed down.
They include the following:’
- Cost of raw materials.
- Power (electricity bill related to production).
- Transport/distribution cost.
- Cost of direct labour.
- Running expenses of fixed capital goods, e.g. petrol, diesel. engine oil. etc.
- Ordinary repairs and routine maintenance of fixed capital goods.
- Other costs directly related to production or factory.
Variable costs are also refereed to as:
- Prime cost.
- Direct cost.
- Avoidable cost.
Types of variable costs
Variable costs are in two forms:
- Total Variable Cost.
- Average Variable Cost.
1) Total Variable Cost (TVC)
“Total variable cost is the sum of all variable costs in the firm”. The larger the quantity produced, the greater the total variable cost. We recall that total variable cost may not exist if goods are not being produced, i.e. the firm is temporarily closed down.
Its curve slopes upward from left, point of origin (zero output), to right. This implies (means) that the greater the output, the larger the total variable cost, Thus it is similar to normal supply curve.
Reasons for the curve’s shape
If output is zero, total variable cost is also zero; it wouldn’t be incurred. Hence total variable cost curve takes its origin from zero. That is, its curve starts from zero. As soon as production starts, and output rises, variable costs come into existence and rise upward accordingly. Thus its curve takes upward sloping shape.
Total Variable Cost (TVC) is calculated with the following formulas::-
- TVC = sum of all variable costs in a firm.
- TVC = TC – TFC.
We recall that ‘TC’ is total cost, while ‘TFC’ is total fixed cost.
2) Average Variable Cost (AVC)
“It is a variable cost per unit.”. It is total variable cost divided by total units produced per period.
Its curve has ‘U’ shape. Firstly, it slopes downward and subsequently (after some time), it gradually rises upward to assume ‘U’ shape.
Reason for the curve’s shape
The shape is best explained with the law of returns. As output increases, unit cost falls due to increasing returns. This makes the curve to slope downwards. However, after sometimes, unit cost starts to rise due to decreasing returns. And this makes it to swing (gradually rise) up to assume ‘U’ shape.
Average Variable Cost is obtained by dividing total variable costs by output (quantity produced). This and its alternative are given belo
2. AVC = ATC – AFC.
- ATC refers to Average total cost.
- TVC= Total variable cost.
- AFC = Average fixed cost.