Despite their superficial similarities, “variable cost” and “average variable cost” really relate to two quite different monetary numbers. To see how production and expenses have changed over time, it is helpful to calculate an average variable cost. The term “variable cost” is often used to refer to the costs that change depending on the quantity produced. Follow this formula to get the average value of the variable:
The whole variable cost divided by output is the average variable cost.
The variable cost and the average variable cost may not always be the same due to fluctuations in pricing. One must think about the project’s variable costs after having worked on it for a long period. An employee’s hourly wage is variable expenses, however despite being promoted this past year, the employee did not get a raise. The variable costs now will be higher than they were in the past, but the long-term average will stay around the same.
Typically, a U-shaped diagram represents the average variable costs. As a result, a company may utilise average variable costs to determine the optimal manufacturing stoppage point and maximise short-term profits. This gives the company the flexibility to manufacture the greatest quality goods at any time. The company may also use this data to cancel a plan if it determines that the AVC is higher than their own.
The Difference Between Variable and Fixed Expenses
In contrast to variable costs, fixed costs remain the same for any given level of production. Because they are not related to output, a corporation must make payments toward fixed expenditures even if it has not yet produced any profits.
Fixed expenditures include things like rent, employee salaries and benefits, and the cost of insurance and office supplies that a business must pay whether or not it makes a profit. No matter what happens to a company’s production, the rent that is due will remain the same. In spite of the fact that fixed expenses may change over time, any such changes will have no impact on production and are, therefore, categorised as long-term outlays.
Semi-variable costs are a third kind of cost that falls between fixed costs and variable costs. This category includes costs that include both fixed and variable elements. Up to a particular point in production or consumption, expenses are flexible, but once that point is achieved, they are fixed. It is typical for a fixed cost to be incurred even if there is no production.
Focusing on Specifics
In most contexts, the word “relevant range” is used in reference to fixed expenses; nevertheless, variable costs may also have their own relevant range. This may apply to the cost of raw materials as well as labour for a certain product. Let’s take a look at the wholesale bulk pricing model, which allocates different prices to various commodities based on the overall volume of an order.
Quantity of Influence
A company’s operational leverage is equal to the product of its variable and fixed costs. With a nutshell, the risk involved in fixed spending is greater, more leverage is created, and the organization has a greater chance of success. As opposed to fixed costs, which carry the risk of loss, variable costs provide less leverage and less potential for success for the business.