✅ Fixed Cost – Meaning & Examples

Fixed cost is a type of cost that does not change with the level of production or sales .
It remains the same whether you produce 0 units or 10,000 units (within a normal capacity
range).

📌 Simple Definition:
Fixed cost = Cost that stays constant regardless of output.

 The Total Fixed Cost (TFC) curve is a horizontal straight line .

 It remains constant at all levels of output.

 Even at zero production, fixed cost exists.

🏢 Common Examples of Fixed Costs

1️⃣ Rent of Building

 If you pay ₹50,000 per month as factory rent,

 It remains ₹50,000 whether you produce 100 units or 1,000 units.

2️⃣ Salaries (Permanent Staff)

 Manager’s salary = ₹40,000 per month
 Even if production increases or decreases, salary remains fixed.

3️⃣ Insurance Premium

Annual insurance payment does not depend on production level.

4️⃣ Depreciation of Machinery

 Machinery value reduces over time.
 Depreciation expense is fixed every year (if using straight-line method).

📊 Example with Numbers

Suppose a factory produces chairs:

Production Units Total Fixed Cost

0 units ₹1,00,000
100 units ₹1,00,000
500 units ₹1,00,000

👉 Total fixed cost remains same.

But fixed cost per unit decreases as production increases.

🔎 Difference Between Fixed Cost and Variable Cost

Fixed Cost Variable Cost
Does not change with output Changes with output
Example: Rent Example: Raw material
Paid even if production is zero Paid only when producing

✅ Variable Cost – Meaning & Examples

Variable cost is a cost that changes directly with the level of production or output.
If production increases → variable cost increases.
If production decreases → variable cost decreases.
If production is zero → variable cost is zero.
📌 Simple Definition:
Variable Cost = Cost that varies with quantity produced.

🔎 Explanation:

 X-axis → Output (Quantity produced)

 Y-axis → Cost
 TVC curve starts from the origin (0,0)
 It is upward sloping
 Initially increases at a decreasing rate
 Later increases at an increasing rate (due to law of diminishing returns)

👉 When output is zero → TVC is zero.

🏭 Common Examples of Variable Costs

1️⃣ Raw Materials

 More production → rawer material required.

 Example: If 1 chair needs 5 kg of wood, 10 chairs need 50 kg of wood.

2️⃣ Direct Labor (Production Workers)

 If production increases, more labor hours are needed.
 Payment depends on units produced or hours worked.
3️⃣ Electricity Used in Production
 More machine usage → more electricity cost.
 If factory is closed → electricity cost is very low or zero.

📊 Numerical Example
Suppose:

 Variable cost per unit = ₹50

Output (Units) Total Variable Cost (TVC)

0 ₹0
10 ₹500
50 ₹2,500
100 ₹5,000

👉 TVC increases as output increases.

📊 Average Cost (AC)

✅ 1️⃣ Meaning of Average Cost

Average Cost (AC) is the cost per unit of output.

It tells us how much cost is incurred to produce one unit of output.

📌 2️⃣ Formula of Average Cost

AC = Total Cost (TC) ÷ Quantity (Q)

Where,

TC=TFC+TVC

Therefore,

AC = AFC + AVC
Where:

AFC = TFC ÷ Q

AVC = TVC ÷ Q

📊 3️⃣ Average Cost (AC) Curve

🔎 Explanation:

 X-axis → Output (Q)

 Y-axis → Cost
 AC curve is U-shaped

Why U-shaped?

1️⃣ Initially Falls

 Due to better utilization of fixed factors

 AFC decreases
 Economies of scale

2️⃣ Minimum Point

 Optimum level of production

3️⃣ Rises After That

 Due to Law of Diminishing Returns

 Diseconomies of scale
 📊 Numerical Example
 Suppose:

Output TFC TVC TC AC

1 100 50 150 150
2 100 80 180 90
5 100 200 300 60

 AC decreases initially, then will increase later.

📊 Marginal Cost (MC)

✅ 1️⃣ Meaning of Marginal Cost

Marginal Cost (MC) is the additional cost incurred to produce one more unit of output.

It tells us how much total cost increases when output increases by one unit.

📌 2️⃣ Formula of Marginal Cost

MC = Change in Total Cost (ΔTC) ÷ Change in Quantity (ΔQ)

Since fixed cost does not change,

MC = Change in TVC ÷ Change in Q

📊 3️⃣ Marginal Cost (MC) Curve

🔎 Explanation:

 X-axis → Output (Q)

 Y-axis → Cost
 MC curve is U-shaped

Why U-shaped?

1️⃣ Initially Falls

 Better utilization of fixed factors

 Increasing returns

2️⃣ Reaches Minimum Point

3️⃣ Then Rises

 Due to Law of Diminishing Returns

 Overuse of variable factors

4️⃣ Relationship Between MC and AC

 MC cuts AC at its minimum point
 If MC < AC → AC is falling
 If MC > AC → AC is rising
 If MC = AC → AC is minimum
 Output TC MC
1 100 –
2 150 50
3 180 30
4 220 40

MC = Change in TC

Example:
MC at 4th unit = 2️2️0 − 1️80 = 40

Combined Short Run Cost Curves

🔎 Diagram Explanation
1️⃣ AFC (Average Fixed Cost)

 Downward sloping curve

 Rectangular hyperbola
 Never touches X-axis
 Continuously decreases as output increases
2️⃣ AVC (Average Variable Cost)

 U-shaped curve
 Initially falls (better utilization of variable factors)
 Then rises (Law of Diminishing Returns)

3️⃣ AC (Average Cost / ATC)

 Also U-shaped
 AC = AFC + AVC
 Lies above AVC
 Gap between AC & AVC = AFC
 Gap decreases as output increases

4️⃣ MC (Marginal Cost)

 U-shaped curve
 Cuts AVC at its minimum point
 Cuts AC at its minimum point
 If MC < AC → AC falling
 If MC > AC → AC rising

📊 Cost–Output Relationship (Short Run & Long Run)

The Cost–Output Relationship explains how cost changes when output (production level)
changes.

It is studied in two periods:

1️⃣ Short Run (some factors fixed)
2️⃣ Long Run (all factors variable)

🔹 I. Short Run Cost–Output Relationship

(In short run, at least one factor like land/machinery is fixed)
📈 Short Run Cost Curves

1️⃣ Total Cost Curves

✔ Total Fixed Cost (TFC)

 Horizontal straight line

 Does not change with output
✔ Total Variable Cost (TVC)

 Starts from origin

 First increases slowly
 Then increases rapidly

✔ Total Cost (TC)

TC=TFC+TVC

 Shape similar to TVC

 Vertical distance between TC & TVC = TFC

2️⃣ Per Unit Cost Curves

✔ AFC (Average Fixed Cost)

 Downward sloping
 Rectangular hyperbola

✔ AVC (Average Variable Cost)

 U-shaped

✔ AC (Average Cost)

 U-shaped
 AC = AFC + AVC

✔ MC (Marginal Cost)

 U-shaped
 Cuts AVC & AC at their minimum points

🔎 Why U-Shape in Short Run?

Because of Law of Diminishing Returns:

 Initially → Increasing returns → Cost falls

 Later → Diminishing returns → Cost rises
🔹 II. Long Run Cost–Output Relationship
(In long run, all factors are variable)

📈 Long Run Average Cost (LRAC) Curve

🔎 Explanation
LRAC is also called the Envelope Curve because it touches all short-run AC curves.

3 Stages:

1️⃣ Economies of Scale → Cost decreases

2️⃣ Constant Returns to Scale → Cost minimum
3️⃣ Diseconomies of Scale → Cost increases

📊 Economies of Scale (Internal & External)

✅ Meaning
Economies of Scale refer to the reduction in average cost of production as the scale of output
increases.
When a firm expands production, cost per unit decreases due to better efficiency and
advantages of large-scale production.

🔹 Types of Economies of Scale

1️⃣ Internal Economies of Scale
2️⃣ External Economies of Scale

🔵 1️⃣ Internal Economies of Scale

👉 These are the advantages enjoyed by a single firm when it expands its own production.

🔎 Types of Internal Economies

1️⃣ Technical Economies

 Use of advanced machinery

 Better technology
 Division of labour

Example: A large automobile plant using automated machines.

2️⃣ Managerial Economies

 Specialized managers for different departments

 Better supervision

3️⃣ Financial Economies

 Large firms get loans at lower interest rates

 Better credit facilities

4️⃣ Marketing Economies

 Bulk buying of raw materials

 Lower advertising cost per unit
5️⃣ Risk-bearing Economies

 Large firms can diversify production

 Risk gets spread

🔵 2️⃣ External Economies of Scale

👉 These are the advantages enjoyed by all firms in an industry when the industry expands.

🔎 Types of External Economies

1️⃣ Economies of Concentration

 Development of industrial areas

 Better infrastructure (roads, transport)

2️⃣ Economies of Information

 Research institutions
 Market information availability

3️⃣ Economies of Welfare

 Better labour training

 Housing and facilities for workers

📉 Diseconomies of Scale

✅ Meaning
Diseconomies of Scale occur when a firm expands production beyond an optimal level and the
average cost per unit starts increasing.
👉 After a certain size, expansion becomes inefficient.

🔹 Types of Diseconomies of Scale

🔵 1️⃣ Internal Diseconomies

(Problems within the firm)

✔ Managerial Problems

 Too many layers of management

 Poor coordination
 Slow decision-making

✔ Communication Gap

 Large organization → communication becomes difficult

✔ Lack of Control

 Supervision becomes weak

✔ Labour Problems

 Worker dissatisfaction
 Strikes, conflicts

🔵 2️⃣ External Diseconomies

(Problems due to industry expansion)

✔ Shortage of Raw Materials

✔ Increase in Input Prices
✔ Transport Congestion
✔ Increased Competition for Resources
📌 Causes of Diseconomies of Scale
1️⃣ Over-expansion
2️⃣ Inefficient management
3️⃣ Coordination problems
4⃣ Rising factor prices

📊 Returns to Scale
(Increasing, Constant & Decreasing)

✅ Meaning
Returns to Scale refer to the relationship between proportionate change in inputs and
proportionate change in output in the long run (when all factors are variable).

👉 If we increase all inputs (labour, capital, land) in the same ratio, how does output change?

🔵 1️⃣ Increasing Returns to Scale (IRS)

📌 Definition:

When output increases more than proportionate ly compared to increase in inputs.

Example:

 Inputs increased by 10%

 Output increases by 20%

🔎 Why It Happens?

 Specialization
 Better technology
 Economies of scale

📊 Effect on Cost:

 Long Run Average Cost (LRAC) falls

🔵 2️⃣ Constant Returns to Scale (CRS)
📌 Definition:

When output increases in the same proportion as inputs.

Example:

 Inputs increased by 10%

 Output increases by 10%

🔎 Reason:

 Optimum utilization of resources

📊 Effect on Cost:

 LRAC remains constant

🔵 3️⃣ Decreasing Returns to Scale (DRS)

📌 Definition:

When output increases less than proportionately compared to inputs.

Example:

 Inputs increased by 10%

 Output increases by 5%

🔎 Why It Happens?

 Management inefficiency
 Coordination problems
 Diseconomies of scale

📊 Effect on Cost:

 LRAC rises
📊 Break-Even Analysis

✅ Meaning
Break-Even Analysis is a technique used to determine the level of output or sales at which
Total Revenue (TR) = Total Cost (TC).

👉 At this point:

 No Profit
 No Loss

This point is called the Break-Even Point (BEP).

 Law of Variable Proportions
The Law of Variable Proportions is a short-run production law in economics. It explains how
output changes when one factor of production is varied while other factors remain fixed.

🔹 Definition
The Law of Variable Proportions states that:

When one factor of production is increased while keeping other factors constant, total output first
increases at an increasing rate, then at a decreasing rate, and finally may decrease.

It is also known as the Law of Diminishing Returns (in short-run production).

🔹 Assumptions
1. Technology remains constant.
2. Only one factor (e.g., labor) is variable.
3. Other factors (e.g., land, capital) are fixed.
4. Units of the variable factor are homogeneous.
5. Production is measured in physical units.

🔹 Three Stages of the Law

Stage 1 – Increasing Returns

 Total Product (TP) increases at an increasing rate.

 Marginal Product (MP) increases.
 Better utilization of fixed factors.
 Ends when MP is maximum.

Stage 2 – Diminishing Returns

 TP increases at a decreasing rate.

 MP decreases but remains positive.
 Most rational stage of production.
 Ends when MP = 0.

Stage 3 – Negative Returns

 TP starts decreasing.
 MP becomes negative.
 Overcrowding of variable factor.
 TP Curve: First rises rapidly, then slowly, then declines.

 MP Curve: Rises, reaches maximum, then falls and becomes negative.

 AP Curve: Rises, reaches maximum, then falls.

🔹 Relationship Between TP, MP and AP

 When MP > AP → AP rises.
 When MP = AP → AP is maximum.
 When MP < AP → AP falls.
 When MP = 0 → TP is maximum.
🔹 Example
Suppose a farmer increases labor on fixed land:

Labor Total Product

1 10
2 25
3 45
4 60
5 70
6 75
7 72

Here:

 Output increases rapidly at first.

 Then increases slowly.
 Finally decreases → showing the law.

Returns to Scale
Returns to Scale refers to the change in output when all factors of production are increased in
the same proportion (long-run concept).

🔹 Definition
Returns to Scale explain how output responds when all inputs (labor, capital, land, etc.) are
increased proportionately in the long run.

🔹 Types of Returns to Scale

1️⃣ Increasing Returns to Scale (IRS)

 Output increases more than proportionately to inputs.

 Example: Inputs ↑ by 1️0%, Output ↑ by 2️0%.
 Reasons:
o Better specialization
 o Technical advantages
o Economies of scale

2️⃣ Constant Returns to Scale (CRS)

 Output increases in the same proportion as inputs.

 Example: Inputs ↑ by 1️0%, Output ↑ by 1️0%.
 Firm operates efficiently at optimal scale.

3️⃣ Decreasing Returns to Scale (DRS)

 Output increases less than proportionately to inputs.

 Example: Inputs ↑ by 1️0%, Output ↑ by 5%.
 Reasons:
o Managerial difficulties
o Coordination problems
o Diseconomies of scale

 In IRS, isoquants get closer.

 In CRS, isoquants are equally spaced.

 In DRS, isoquants get farther apart.

🔹 Numerical Example
Inputs (L & K) Output
1:1 100
2:2 250 → IRS
3:3 300 → DRS
 Basis Law of Variable Proportions Returns to Scale
Time Period Short Run Long Run
Factors Changed One variable factor All factors
Application Production behavior Scale of production

Cost–Volume–Profit (CVP) Analysis

Cost–Volume–Profit (CVP) Analysis studies the relationship between cost, sales volume, and
profit. It helps firms determine the level of sales needed to earn profit or avoid loss.

🔹 Meaning
CVP Analysis examines how changes in cost and volume affect a company’s operating profit.

It is also known as Break-Even Analysis.

🔹 Key Concepts in CVP

1. Fixed Cost (FC) – Cost that does not change with output (e.g., rent).
2. Variable Cost (VC) – Cost that varies with output.
3. Total Cost (TC) – FC + VC.
4. Selling Price (SP) – Price per unit sold.
5. Contribution (C) – SP − VC per unit.
6. Profit – Total Contribution − Fixed Cost.

🔹 Break-Even Point (BEP)

The Break-Even Point is the level of sales where:

Total Revenue = Total Cost

Profit = 0
 The point where Total Revenue line intersects Total Cost line is BEP.

 Left of BEP → Loss

 Right of BEP → Profit

🔹 Numerical Example
Fixed Cost = ₹1️0,000
Selling Price per unit = ₹50
Variable Cost per unit = ₹3️0

Contribution per unit = 50 − 3️0 = ₹2️0

BEP=10000/ 20= 500 Units

So, the firm must sell 500 units to avoid loss.

🔹 Margin of Safety (MOS)

 MOS=Actual Sales−Break-even Sales

It shows how much sales can fall before loss begins.

🔹 Assumptions of CVP Analysis

1. Costs are classified into fixed and variable.
2. Selling price remains constant.
3. Production equals sales.
4. Efficiency and technology remain constant.