>> So as far as an example scenario is concerned, let's keep things simple and assume we have the following information. The first is we are producing a good and each good costs us in terms of variable costs $1 per unit. The second piece of information suggests that our fixed costs are $100,000 in total. And third we know that the production volume in which we're interested is 1 to 100,000 units. So to exemplify variable versus fixed costs, let's start with variable costs. And let's think of total variable costs to begin with. Now this graph on the horizontal axis is production volume starting with 0 or 1 up to 100,000. And on the vertical axis we range from low costs to high costs. Now again this is total variable costs. So over the range of production volume from low levels to high levels, the graph of total variable costs would look like an upward sloping line. The reason is that total variable costs increase with production volume. The fewer units you produce, the less your total variable cost. Each additional unit costs us an additional dollar. So as we move from left to right on the production volume line, total variable costs increase. Now where this comes from is the fact that unit variable costs are per unit amount. So again looking at the horizontal axis we have production volume from low levels to high levels and on the vertical axis we have cost. But in this case it's per unit. With variable costs by definition we're told that it's $1 per unit. So the graph of that line would be a flat line. In this case unit variable costs do not change with production volume. It's always $1 per unit no matter where we are on that production volume line. On the flip side we can think about fixed costs. And again let's start at the total. Same deal. Horizontal axis, low levels of production volume to high levels of production volume. And the vertical axis we're back to total cost. Fixed costs do not change over production volume by definition. So this line would be flat. This is because total fixed costs do not change over varying levels of production volume. Taking this the fixed costs and putting them in per unit terms makes the graph look different. Again, horizontal axis is production volume, low to high levels. And vertical axis we're back to a unit cost. When we produce very few units, say one, then we have a very significant amount of fixed cost just to produce that one unit. In fact, we have $100,000 that we spent for one unit and so that would yield a very significant per unit fixed cost, $100,000. As we produce more units, the per unit fixed costs gets smaller. It's the same dollar amount, the same $100,000 spread over larger and larger volume. So unit fixed costs vary with production volume. The higher production volume, lower unit fixed costs. Now in these graphs what's apparent is that all these lines are drawn as though they are straight. And in reality is everything really that linear? Well, let's think about variable cost for a second. Going back to that graph, we said that unit variable cost is a flat line. The reason being unit variable cost do not change with production volume. But you can think of a very common example where a firm is engaged in learning curves. So early on in its existence or when it's producing very few units, the cost per unit is actually quite significant. And then over time or over larger volumes the firm engages or enjoys economies of scale. In this case the unit variable cost decreases compared to lower production volumes. So this graph drawn linearly here would likely have non-linearities as we enter into the real world. The same would go for total fixed costs. We said that regardless of production volume from 1 to 100,000, we spend the same amount on fixed costs, $100,000. But imagine if the firm were to produce more and more units. If this was the case, then it might take a new factory or additional management salaries to produce these higher levels. And in this case we might see a step-up in the amount of fixed costs from that original $100,000 level to something higher. So even fixed costs are not necessarily linear over all production volumes. So when we graph the total cost, variable and fixed, we can see non-linearities in the true relationship between the units produced or production volume and the total cost spent. But oftentimes when we're doing cost analysis we limit our focus to what we deem to be a relevant range. And in that relevant range, linear patterns and the assumption thereof is good enough. If we're thinking about making decisions that bring us really low on the level of production or relatively much higher, then we're thinking more about strategic decisions and cost analysis needs to be supplemented with something else. So for a lot of purposes we'll just assume linearity for simplicity and also because we're focused on a particular relevant range.
