A Firms Costs

You need to understand some basic concepts of how to analyze a firm's costs.

Fixed Cost

A fixed cost is a cost that does not vary with the quantity a firm produces.

Variable Cost

A variable cost is a cost that changes with the quantity a firm produces.

Sunk Cost

A sunk cost is a fixed cost that cannot be recovered.

Marginal Cost

A marginal cost is the cost of producing one more of something.

Example - Movie Production

A movie production company's cost to produce the first copy of the movie is a fixed cost. It costs the same to make the movie, whether is has ten thousand viewers or ten million.

If the movie production company sells DVDs, the cost of producing DVDs is a variable cost, because it depends on the number of DVDs produced. If the cost per DVD is $2, the total cost will be $2 x number of DVDs produced.

Advertising is another variable cost. The more people you want to see the film, the more you have to spend on advertising. Advertising cost varies with the number of people who see the film.

The marginal cost of a DVD is the cost of producing one more DVD: $2.

If the movie is a dud, the producers cannot recover their investment in production costs (because no-one wants to buy a failed script). The production cost is a sunk cost.

Costs are called "Expenses" in Accounting

Accountants usually refer to costs as expenses. Income statements usually refer to the costs of running a business as "operating expenses."

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