Variable costs, as the name implies, vary over time according to a range of factors. Variable costs differ from fixed costs, which remain constant over time. The principle of variable costs applies to businesses, government agencies, nonprofits and consumers, creating distinct economic implications throughout society. Understanding the ripple effects sent through the economy by changes in variable cost structures can help you to understand and predict economic shifts.
Variable cost calculations have implications for individual economic units, such as households and businesses, as it can introduce uncertainty into budgeting and estimates of future net income. A consumer using a credit card with a variable interest rate, for example, will have to recalculate the total time it will take to pay off the balance making the current payment, each time the interest rate changes. Changes in variable interest rates also effectively increase the total cost of goods and services purchased with credit. Variable costs in the purchasing department can alter an organization's ability to buy the quantities of inventory, supplies or materials it needs to continue doing business at their current rate. For example, if a company is accustomed to purchasing 1,000 units of inventory at $5 per unit, it may have to reduce its normal purchase quantity if the unit price rises to $7.
The microeconomic effects of increasing or decreasing costs can have larger implications for aggregate demand in specific industry sectors, and the economy as a whole. At first glance, decreasing variable costs may seem like an inherently good thing, as it can increase demand throughout supply chains and boost economic metrics, such as employment and lending. However, if variable costs decrease too much or for too long, profitability in certain industries can drop and have the opposite effect. If the prime rate decreases for a prolonged period of time, reducing consumer and business variable interest rates along with it, credit users may be encouraged to make more and larger purchases, but lenders' will begin to struggle to make up for lost profits.
Certain variable cost calculations depend on seasonal factors, displaying regular cost swings in predictable patterns. Fruit serves as a simple example of a product with a seasonal variable cost structure. Restaurants can buy fruit at lower prices locally when it is in season, but must pay predictably higher prices for imported fruit in the off season.
Planning for Variable Costs
Economic entities can employ cost-reducing strategies to take advantage of desirable shifts in variable costs, which can in turn produce their own economic ripple effects. Businesses and consumers can make larger-than-usual purchases when costs drop for frequently purchased goods, which can send an immediate and false signal of an increase in demand to the industry. Credit card companies can introduce new fees and fines to new cardholders in response to prolonged periods of low interest rates, which has microeconomic implications for borrowers.
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