A variable cost function is one of two major cost functions in a company. Accountants or economists track this function as it relates to either production or total cost curves, respectively. The other half to this equation is a company’s fixed costs, which can also represent overhead. In short, the variable cost function changes with any change in a company’s production output, while fixed costs do not. Many different formulas exist in economic analysis to assess the variable costs within a company’s production system.
The variable cost function typically carries the abbreviation VC, which stands for variable cost. AVC stands for average variable cost, another important feature of this cost function. These two abbreviations make it possible for a company to compute various formulas that track the total average cost for a process, designated AC. Fixed costs also carry similar abbreviations, with FC representing fixed costs and AFC average fixed costs. These abbreviations make up the remaining parts of the formula.
The beginning formula to determine average costs is to add together both total fixed costs and total variable costs. Dividing this figure by Q — which stands for quantity — produces the average cost for a given product or process. An alteration to this formula is to add together the average fixed cost and average variable cost for a given product or process. This latter formula produces the same result as the former formula, average cost. The variable cost function here plays an important role in a company’s diminishing returns analysis.
Companies often look to reach an equilibrium point using the average cost formula. The purpose is to find the maximum production point where total average costs equal total average revenue. The variable cost function necessarily increases when a company looks to increase its production output. As the company increases its total average costs, it will reach closer to its planned equilibrium point. At some point, however, variable costs become a drag on a company’s profits.
When a company continues to increase its variable costs with reckless abandon, it will soon enter a diminishing returns process. This occurs because, no matter how much money a company spends to increase production output — and its related variable cost function — the company will not increase profits. A major reason for this comes from consumer demand that has topped out, with no additional supply able to increase sales. The additional costs simply add to the company’s expenses with no hopes of offsetting them with future revenues.