What Every Investor Should Know About Fixed, Variable and Marginal Costs!

Understanding how these costs work together is important for both business owners and investors.

Understanding the Interaction Between Total, Variable, Fixed, and Marginal Cost and Output

When it comes to running a business, it’s important to understand how different costs interact with the number of products you make. These costs—total cost, variable cost, fixed cost, and marginal cost—can help business owners and investors see how well a company is performing. Let's break down these concepts in a simple way and see how they affect the business.

Total Cost

Total cost is simply all the money a company spends to make its products. It includes both fixed costs and variable costs. This total helps us understand how much the company is spending overall, no matter how many products it makes.

Fixed Costs

Fixed costs are the expenses that stay the same, no matter how many products the company makes. These costs are constant, even if the company doesn't produce anything. Examples of fixed costs include rent, salaries for permanent employees, or insurance. So, if a company produces 1 product or 1,000 products, the rent and employee salaries won’t change.

Variable Costs

Variable costs, on the other hand, change depending on how many products the company makes. The more products you produce, the higher your variable costs will be. For example, if you run a bakery, your variable costs would include ingredients like flour, sugar, and eggs. If you bake 10 cakes, your costs will be lower compared to baking 100 cakes.

Marginal Cost

Marginal cost is the extra cost of making one more product. This is an important number for any business because it helps determine whether producing more products is worth the cost. For example, if it costs Rs 50 to make one extra cake, that’s the marginal cost. If you can sell that cake for Rs 100, making one more is a good idea. But if it costs Rs 150 to make the extra cake, it might not be worth it.

How Costs and Output Work Together

When you produce more products, total costs increase because both fixed and variable costs come into play. But fixed costs don’t change when you produce more; they stay the same. So, as you make more products, your variable costs go up (because you need more materials), but the fixed costs remain constant.

Here’s a simple example:

Let’s say you own a small bakery. You pay Rs 10,000 a month for rent (fixed cost) and Rs 20 per cake for ingredients (variable cost). If you make 100 cakes in a month, your total costs would be:

• Fixed costs: Rs 10,000 (rent)
• Variable costs: 100 cakes x Rs 20 = Rs 2,000 (ingredients)
• Total cost: Rs 10,000 + Rs 2,000 = Rs 12,000

Now, if you make 200 cakes, your fixed cost (rent) still stays the same at Rs 10,000, but your variable costs double because you're using more ingredients. So, your new total cost would be:

• Fixed costs: Rs 10,000
• Variable costs: 200 cakes x Rs 20 = Rs 4,000
• Total cost: Rs 10,000 + Rs 4,000 = Rs 14,000

The marginal cost, in this case, is the extra cost to make one more cake. If you add one more cake to your production (going from 200 cakes to 201 cakes), you’re only paying for the ingredients—Rs 20 for that one additional cake. So, the marginal cost is Rs 20.

Conclusion

Understanding how these costs work together is important for both business owners and investors. If you know how much it costs to make each additional unit (marginal cost) and how your total costs increase with production (fixed and variable costs), you can make smarter decisions about how many products to make. For investors, companies that know how to manage their costs effectively are often more successful in the long run, making them good options for investment.

Disclaimer: The article is for informational purposes only and not investment advice.