Types of Costs (DP IB Business Management)

An Introduction to Costs

• In preparing goods/services for sale, businesses incur a range of costs

  • Some examples of these these costs include purchasing raw materials, paying staff salaries and wages, and paying utility bills such as electricity  

• These costs can be broken into different categories

  • Fixed costs (FC) are costs that do not change as the level of output changes

    • These have to be paid whether the output is zero or 5000 

  • Variable costs (VC) are costs that vary directly with the output

    • These increase as output increases & vice versa

  • Total costs (TC) are the sum of the fixed + variable costs 

Comparison of the Types of Cost

Type of Cost	Diagram	Explanation
Fixed Cost (FC)		The firm has to pay its fixed costs which do not change, irrespective if the output is 0 or 100,000 units The fixed costs for this firm are $4,000
Variable Cost (VC)		The variable costs initially rise proportionally with output, as shown in the diagram At some point, the firm will benefit from a purchasing economy of scale and the rise will no longer be proportional
Total Cost (TC)		The total cost is the sum of the variable and fixed costs The total costs cannot be 0 as all firms have some level of fixed costs

Direct & Indirect Costs

• Direct costs are related to the production of a particular product and vary directly with output

  • Examples include raw materials, components and packaging

• Indirect costs cannot be allocated easily to the production of a particular product

  • They relate to the business as a whole and are often called overheads

  • Examples include administration costs, salaries and rental fees

Diagram: direct and indirect Costs