Today's Question
Fixed costs (FC) don't change with output - like rent, insurance, or equipment leases. Variable costs (VC) change with output - like ingredients, hourly wages, or electricity. If a café has $1000 monthly rent and each coffee costs $2 in ingredients, what happens to average cost per coffee as the café sells more coffees? Why?
Model Answer
Average cost falls! With 100 coffees: $1000/100 + $2 = $12 per coffee. With 1000 coffees: $1000/1000 + $2 = $3 per coffee. The fixed costs get 'spread' over more units. This is why businesses want volume - they can lower average costs by spreading fixed costs. This also explains why businesses hate operating below capacity - those fixed costs still hit them hard.