In fact, distinction between prime cost and supplementary cost is not meaningful but distinction between fixed costs and variable costs is crucial in the short-run.
In the long run, all costs become variable as all factors change.
Let us examine the main points of distinction in fixed costs and variable costs:
1. Fixed Costs can Never be Zero:
In the short-run when production is temporarily stopped, there will be no variable costs.
Thus, the variable costs will be zero. But, the fixed costs can never be zero whether a firm produces or not. The fixed costs are always positive.
2. Price Determination:
In short, due to fall in demand, the producer is forced to sell the commodity at low price. In such a situation, the producer will sell the product so long as it covers the variable costs. He will not bother about the fixed costs because he has to bear these costs even at zero level of output.
3. Determinant Factors:
The fixed costs include interest on fixed capital, license fees, wages to permanent staff etc. These factors have no bearing on volume of production. On the other hand, variable costs include electricity and fuel charges, wages to casual employees, interest on working capital etc. which are closely related to the volume of production. Thus, it is clear from the above observation that variable costs are the determinant factors.
4. Relation with Output:
Fixed costs have no relation with output because these costs remain constant whatever be the level of output. On the contrary, variable costs are positively related to output. If output is zero, variable costs will also be zero and vice-versa.
5. Nature of Average Fixed Costs and Average Variable Costs:
Average fixed costs fall with an increase in output whereas average variable costs fall less with the increase in output. The average fixed cost falls throughout and forms the shape of rectangular hyperbola. The average variable cost initially falls as the output increases and later on, it starts rising upward, hence, assumes the shape of “U”.
Summary of the Difference between Fixed Costs and Variable costs: