Numerical

Fixed costs = Total production costs — (Variable cost per unit * Number of units produced)

Fixed Cost Formula/Example

Let us take the example of a company which is the business of manufacturing plastic bottles.
Recently the year-end production reports have been prepared and the production manager
confirmed that 20,000 bottles have been produced during the year.

On the other hand, the accounts department has confirmed that the company has incurred
total production costs of $100,000 during the year. Calculate the fixed cost of production if
the reported variable cost per unit was $3.75.

Ans

Fixed Cost = $100,000 – $3.75 * 20,000 · Fixed Cost = $25,000

Average fixed cost = Total fixed cost / Total number of units produced

Division method

Brisket Biscuit Co. has the following fixed costs:

 Machinery: $25,000
 Rent: $15,000
 Vehicles: $2,000
 Wages: $15,000
 Insurance: $800
 Total:
 Number of units produced over one year: 100,000

Using the division method:

Total fixed cost: 25000 + 15000 + 2000 + 15000 + 800 = 57,800

Number of units: 100,000

Average fixed cost: 57,800/100,000 = $0.58 per unit

Subtraction method

Brisket Biscuit manufacturing company has the following total cost accrued over a
period of one year:

 Materials: $30,000
 Labor: $3,000
 Machinery: $25,000
 Rent: $15,000
 Vehicles: $2,000
 Salaries: $15,000
 Insurance: $800
 Number of units produced over one year: 100,000

Using the subtraction method:

Total cost: 30000 + 3000 + 25000 + 15000 + 2000 + 15000 + 800 = 90,800

Average total cost = total cost / quantity produced

ATC= 90,800 / 100,000 = $0.91

To calculate average variable cost: total variable cost / quantity produced

Total variable cost: cost of labour + cost of materials

Total variable cost = 30,000 + 3000 = 33,000

Average variable cost (AVC): 33,000 / 100,000 = $0.33

Average fixed cost (AFC) = average total cost - average variable cost

Average fixed cost = 0.91 - 0.33 = $0.58

The formula to calculate incremental cost is as follows:

Total cost of producing two items - the total cost of producing one item = incremental cost

1. Determine your base production amount

The most basic formula for incremental cost uses a base production amount of one unit. The
base production amount is what you use to compare the additional unit cost, so many
businesses may use the amount they can produce in a set time, such as an hour or a day.
When you work on a scale larger than one unit and an additional unit, you can examine how
economies of scale impact your costs.
2. Add the variable costs for your base amount

When you are adding the variable costs for your base amount, calculate how much you pay
for direct labour to produce the item and how much raw materials cost. For example, if it
takes 30 minutes to produce a widget with $20 of raw materials and you pay a worker $15 per
hour, your calculation would be:

(15/2) + 20
7.5 + 20
27.5

This means that the variable cost for one widget is $27.50.

3. Calculate the cost for the additional product

The additional product may take less time to produce than the first because your employee is
working more efficiently. For example, the second widget from the previous example may
only take 15 minutes to produce, which means that you pay your employee for 45 minutes of
work. The calculation for the additional product would be:

(15 x 0.75) + 40
11.25 + 40
51.25

4. Find the incremental cost

The incremental cost is how much more you would spend producing an additional item. The
incremental cost calculation for producing the second widget from the current example would
be:

51.25 - 27.5 = 23.75

This means that the incremental cost to make the second widget is $23.75.

If you are calculating the incremental cost for more than one unit, you can divide the final
incremental amount by the difference in items produced. For example, if you find it costs
$3,000 to create 300 items and $3,500 to create 400 items, your calculation would be:

(3,500-3,000)/100
500/100
5

This calculation shows that the incremental cost per item you produce over 300 is $5.
What Is Marginal Cost?

In economics, the marginal cost is the change in total production cost that comes from
making or producing one additional unit. To calculate marginal cost, divide the change in
production costs by the change in quantity.

The purpose of analyzing marginal cost is to determine at what point an organization can
achieve economies of scale to optimize production and overall operations.

If the marginal cost of producing one additional unit is lower than the per-unit price, the
producer has the potential to gain a profit.

KEY TAKEWAY

 Marginal cost is an important concept in managerial accounting, as it can help an

organization optimize its production through economies of scale.
 A company can maximize its profits by producing to where marginal cost (MC)
equals marginal revenue (MR).
 Fixed costs are constant regardless of production levels, so higher production leads to
a lower fixed cost per unit as the total is allocated over more units.
 Variable costs change based on production levels, so producing more units will add
more variable costs.
 Companies must be mindful of when increasing production necessitates results in
step costs due to changes in relevant ranges (i.e. additional machinery or storage
space needed).

Marginal Cost Formula

Marginal cost is calculated as the total expenses required to manufacture one additional

good. Therefore, it can be measured by changes to what expenses are incurred for any given
additional unit.

Marginal Cost = Change in Total Expenses / Change in Quantity of Units Produced

Benefits of Marginal Cost

 When a company knows both its marginal cost and marginal revenue for various
product lines, it can concentrate resources towards items where the difference is the
greatest. Instead of investing in minimally successful goods, it can focus on making
individual units that maximum returns.

 Marginal cost is also essential in knowing when it is no longer profitable to

manufacture additional goods.

 When marginal cost exceeds marginal revenue, it is no longer financially profitable

for a company to make that additional unit as the cost for that single quantity exceeds
the revenue it will collect from it.
  Using this information, a company can decide whether it is worth investing in
additional capital assets.

What Is the Difference Between Marginal Cost and Average Cost?

Marginal cost is the expenses needed to manufacture one incremental good. As a

manufacturing process becomes more efficient or economies of scale are recognized, the
marginal cost often declines over time. However, there is often a point in time where it may
become incrementally more expensive to produce one additional unit.

On the other hand, average cost is the total cost of manufacturing divided by total units
produced. The average cost may be different from marginal cost, as marginal cost is often
not consistent from one unit to the next. Marginal cost is reflective of only one unit, while
average cost often reflects all unit produced.

Short run marginal cost

 Short run marginal cost is the change in total cost when an additional output is
produced in the short run and some costs are fixed. On the right side of the page, the
short-run marginal cost forms a U-shape, with quantity on the x-axis and cost per unit
on the y-axis.
 On the short run, the firm has some costs that are fixed independently of the quantity
of output (e.g. buildings, machinery). Other costs such as labour and materials vary
with output, and thus show up in marginal cost.
 The marginal cost may first decline, as in the diagram, if the additional cost per unit is
high if the firm operates at too low a level of output, or it may start flat or rise
immediately.
 At some point, the marginal cost rises as increases in the variable inputs such as labor
put increasing pressure on the fixed assets such as the size of the building.
 In the long run, the firm would increase its fixed assets to correspond to the desired
output; the short run is defined as the period in which those assets cannot be changed.

Long run marginal cost

  The long run is defined as the length of time in which no input is fixed. Everything,
including building size and machinery, can be chosen optimally for the quantity of
output that is desired.
 As a result, even if short-run marginal cost rises because of capacity constraints, long-
run marginal cost can be constant. Or, there may be increasing or decreasing returns
to scale 
 if technological or management productivity changes with the quantity. Or, there may
be both, as in the diagram at the right, in which the marginal cost first falls (increasing
returns to scale) and then rises (decreasing returns to scale).[3]

This can be compared with average total cost (ATC), which is the total cost (including fixed
costs, denoted C0) divided by the number of units produced:

Marginal Cost Example

Output (units) Total Cost Average Cost Marginal Cost

10 (Fixed
0 ∞ -
Cost)

1 30 30 20

2 40 20 10

3 48 16 8
Examples of opportunity cost

The cost of war. If the government spends $870bn on a war, it is $870bn they cannot spend
on education, health care or cutting taxes / reducing the budget deficit.
Spending on new roads. If the government build a new road, then that money can’t be used
for alternative spending plans, such as education and healthcare.
Tax cuts. If the government offers an income tax cut, the opportunity cost is that government
revenue cannot be used to finance some aspect of government spending.
Time. If you have 12 hours at your disposal during the day, you could spend these hours in
work or leisure. The opportunity cost of spending all day watching TV is that you are not able
to do any study during the day.

Example of Actual Opportunity Cost

Suppose you buy a new car for £10,000. After three years it has depreciated in value to
£3,000. What is the opportunity cost of deciding to keep the car?

 The opportunity cost of keeping the car is the £3,000 you could have got for selling
the car. The price you bought it for is not relevant here.