The different types of cost can be used to solve break even, make vs. buy, and optimal pace problems. The two types of cost are fixed and variable cost. The textbook mentions a third type of cost called semi-variable cost which is a mixture of the other two types of cost. Semi-variable cost will not be discussed in the following transcript.

Fixed costs are costs that do not change. For example if you take a loan out on a car or house the payments are the same from month to month. The statistical definition is that fixed costs are uncorrelated with the volume index. The volume index is the amount that is produced. Going along with the car example the volume index would refer to the number of the type of car you purchased that are on the market. If you were to graph the relationship between fixed cost on the y-axis and the volume index on the x-axis you would graph a horizontal line.

Variable costs are costs that do change. For example the cost of books changes from quarter to quarter. The statistical definition is that variable costs are correlated with the volume index. If you were to graph the relationship between fixed cost on the y-axis and the volume index on the x-axis you would get a graph that was something other then a horizontal line.

When the fixed and variable costs are added together you get what is known as the total cost. An example of this is you own a business that rents a building. Assume that employeeâ€™s wages are neglected for this example. The rent is a fixed cost while the changing inventory is a variable cost that is dependent on how much merchandise you sell and how much merchandise you keep on hand. Added the rent to the cost of the merchandise gives you the total cost of running the business.