Question

Explain the difference between fixed and variable costs. Give an example of a cost that varies with the number of miles you drive your car each week and an example of a cost that is fixed regardless of how many miles you drive your car each week.

Answer 1

The difference between fixed costs and variable costs exist only in shortrun. In longrun the difference does not exist since all factors can be varied in longrun. Fixed costs are the cost which do not change with the change in output. These are the cost on fixed factors of production. For example a firm invests in machine, plants, land and building and the firm pays wages and salaries to the permanent staff. These costs remaining constant during short period when output expanded or contracted. Thus fixed costs are those cost which remain constant irrespective of the change in the volume of output.

On the other hand, variable costs are the consts on variable factors. These are cost on variable factors like raw materials, wages to the casual workers, expenses on electricity etc. Since these factors can be varied in shortrun they changes with the changes in output. In other words variable costs increase with increase in output and decrease with decrease in output.

Differences

Fixed cost	Variable cost
1. Cost incurred on fixed factors	Cost incurred on variable factors
2. Do not change with output	Change with output
3. Remain fixed even when output is zero	Zero when output is zero
4. It is incurred before the production of output starts.	Incurred only when production of output actually starts.
5. The fixed cost per unit decrease with increase in production and increase with decrease in volume of production.	Variable cost per unit remaining constant.

For example in case of car driving, the cost on the purchase of car and its insurance and its cost on the legal formalities of its ownership remaining the same. They do not increase or decrease with the amount of miles you drive in a day or a week. They are fixed costs of driving.

But the cost on the fuel you incur for driving the car varies with the amount of miles you drive. Thus the expenditures on fuel (petrol or diesel) vary with the amount of miles of driving. Hence they are variable cost. When you are not driving, the variable cost on your driving is zero, but the fixed cost is equal to the fixed expenditure.