Question

Explain Fixed cost, Variable cost and Total cost.

Hint:

Short run identity: $TC=TFC+TVC$. $AFC$ falls forever; $MC$ meets $AVC$ and $ATC$ at their minima.

Answer 1

Fixed Cost (TFC): Costs that do not vary with output in the short run—rent of factory, insurance, salaries of permanent staff, depreciation. Even when output is zero, TFC is incurred; hence TFC is a horizontal line with respect to output.
Variable Cost (TVC): Costs that change directly with output—wages of casual labour, raw materials, power, packaging. TVC is zero at zero output and typically rises at a decreasing then increasing rate due to returns to the variable factor.
Total Cost (TC): Sum of fixed and variable costs: $TC = TFC + TVC$. Average and marginal counterparts are $AFC=TFC/Q$ (always falling), $AVC=TVC/Q$, $ATC=TC/Q$, and $MC=\Delta TC/\Delta Q$. In the short run, $AVC$, $ATC$, and $MC$ are typically U-shaped, with $MC$ cutting $AVC$ and $ATC$ at their minimum points.