Costs (A level BS)
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Start up costs
Start up costs are those costs that a business must pay before it can open, examples of these include paying for market research and buying premises, machinery and fixtures and fittings.
Running costs
Running costs are those costs that a business must pay once it has opened, for example, advertising the product, paying rent on the premises, paying for power to run the machinery, paying government taxes on sales and paying for raw materials and workers’ wages. There is a difference between fixed and variable costs.
Fixed costs
Fixed costs are those that have to be paid no matter how much the business produces. In fact the business still has to pay its fixed costs even if it doesn’t produce anything. An example of a fixed cost is rent; Pizza Hut will have to pay the same rent for its restaurant if it sells 1000 or no pizzas a night. Other examples of fixed costs are business rates and interest charges on loans. We can show the level of fixed costs for Pizza Hut on the diagram below. Their fixed costs are shown as a straight horizontal line at £5,000, this shows Pizza Hut will have to pay £5,000 per week no matter how many pizzas they sell.
Variable costs
Variable costs increase as output increases. This is because Pizza Hut will have to spend more money if they want to produce more pizzas, for example, if Pizza Hut doubled the number of pizzas they sold you would expect their costs to go up. The ingredients used to make pizzas are an example of a variable cost; this is because Pizza Hut will have to buy more ingredients if they want to sell more pizzas. Other examples of variable costs are delivery costs and chefs’ wages. Variable costs are shown as an upward sloping line; this shows that as the number of pizzas sold increases so do the variable costs.
Fixed or variable cost?
Fixed and variable costs are a simple way of splitting up the different types of cost. However it can be more difficult to decide whether some costs are either fixed or variable. Are the mopeds Pizza Hut use for delivery a fixed or variable cost? You could argue that they are a fixed cost because Pizza Hut have to pay the tax and insurance on them no matter how may deliveries they make. You could also argue that they are a variable cost because the more deliveries Pizza Hut make the more petrol the mopeds will use. To get over this problem we would call the moped a semi-variable cost, in other words part of it is fixed and part of it is variable.
Total costs
Total costs are equal to fixed plus variable costs. We can show fixed costs on the diagram below. Note that the total costs line doesn’t start from the origin (0) because of the fixed costs the business has to pay when output is zero.
Direct costs
These are costs that can be directly attributed to the production of a particular good or service, e.g., raw materials and piece rate wages.
Indirect costs (overheads)
These can’t be directly linked to a good or service. They can be difficult to control and managers have to be aware of them, e.g., depreciation, management, administration and marketing.
