Fixed costs are costs incurred by the firm on fixed factors of production that do not vary with any change in the level of output such as the expenditures on the insurance premium, cost of equipment and renovation cost. As for variable costs, the firm incurred this cost when the firms increases the usage of variable factors of production that will vary with the change in the level of output such as the expenditures on wages, utility charges and inventory cost.
This fixed cost is still incurred by the firm even when the production is zero and remains the same as the production level increases. As for the variable costs, it will only be incurred when the production increases and it can change at different rate as the production increases, depending on the law of diminishing returns which will depict the efficiency of utilization of fixed factors by variable factors.
When the cost is measured in average basis, the average fixed cost will falls sharply at the initial stage and more gently at the later stage as the total fixed cost is only dividable by a smaller output level at the initial stage and a larger output level at the later stage of production. As for average variable costs, it will decrease at the initial stage as marginal product is increasing due to more efficient rate of utilization of fixed factors by the variable factors but it will increase when there is over-utilization of the fixed factors by the variable factors.
