Types of Costs (HL IB Business Management)

• 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 
    • E.g. building rent, management salaries, insurance, bank loan repayments etc.
      
      
  • Variable costs (VC) are costs that vary directly with the output
    • These increase as output increases & vice versa
    • E.g. raw material costs, wages of workers directly involved in the production
      
      
  • Total costs (TC) are the sum of the fixed + variable costs 
    
    

Sketches Which Represent the Different 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 costs are related to the production of a particular product and vary directly with output
  • They are often the same as variable costs 
  • Examples include raw materials, components and packaging
    
    
• Indirect costs cannot be allocated easily to the production of a particular product
  • They are often the same as fixed costs
  • They relate to the business as a whole and are often called overheads
  • Examples include administration costs, salaries and rental fees
    
    

Examples of direct and indirect costs for a chocolate manufacturer