Total cost (TC) in economics and accounting refers to the complete cost of producing a certain quantity of a product or service. It includes both variable costs (VC) and fixed costs (FC).
- Variable Costs (VC): These are costs that change in proportion to the level of production or the quantity of output. Examples include raw materials, direct labor, and other expenses that increase as more units are produced.
- Fixed Costs (FC): These are costs that remain constant regardless of the level of production or the quantity of output within a certain range. Examples include rent, salaries of permanent staff, and machinery maintenance costs.
The formula for total cost is:
Total Cost (TC) = Fixed Costs (FC) + Variable Costs (VC)
Or, when considering production levels,
TC(Q) = FC + VC(Q)
- TC(Q) is the total cost of producing Q units.
- FC is the fixed cost, which remains constant regardless of the quantity produced.
- VC(Q) is the variable cost of producing Q units.
The concept of total cost is crucial in various areas of business, such as pricing decisions, profitability analysis, and cost management.
It’s important to note that the total cost can change due to various factors, such as economies of scale (a proportionate saving in costs gained by an increased level of production) and changes in input prices.
Example of the Total Cost
Let’s delve into a hypothetical scenario to understand the concept of total cost.
Scenario: “Prestige Pens Ltd.”
Prestige Pens Ltd. manufactures luxury pens. The company has fixed monthly costs that include rent, salaries of permanent staff, and machinery depreciation. Additionally, it incurs variable costs based on the number of pens produced, such as raw materials and direct labor.
- Monthly Fixed Costs (FC): $10,000
- Variable Cost per pen (VC): $5
Let’s say in a particular month, Prestige Pens plans to produce 2,000 pens.
- Total Variable Costs for producing 2,000 pens:
Total VC = Variable Cost per pen × Number of pens
Total VC = $5 x 2,000 = $10,000
- Total Cost for producing 2,000 pens:
Total Cost (TC) = Fixed Costs (FC) + Total Variable Costs (Total VC)
TC = $10,000 (FC) + $10,000 (Total VC) = $20,000
To produce 2,000 pens, Prestige Pens Ltd. will incur a total cost of $20,000. This includes both the constant monthly expenses (fixed costs) of $10,000 and the costs directly associated with producing the 2,000 pens (variable costs) which also amount to $10,000.
Understanding this total cost is essential for Prestige Pens Ltd. when setting selling prices, estimating profitability, and making production decisions. For instance, if they decide to sell each pen for $15, they would generate a revenue of $30,000 for 2,000 pens. Subtracting the total cost from this revenue would give them a profit for the month.