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Generally, the larger the volume (quantity) to be produced, the greater the opportunity to use special-purpose, automatic, or automated pro­cesses. Capital cost for such things as machinery, special tools, or fix­tures is usually high. Capital costs are called "fixed costs" and the pro­duction, or run, costs are called "variable costs."

Fixed costs do not vary with the volume being produced. Costs such as the purchase of machinery and tools and setup costs are con­sidered fixed costs. No matter what volume is produced, these costs remain the same. If it costs $200 to set up a process, this cost will not change no matter how much is produced at one time.

Variable costs vary with the quantity produced. Direct labor and direct material are the major variable costs. If the run time for a prod­uct is 15 minutes per unit, the labor cost $ 10 per hour, and the material cost $20 per unit then the variable cost is:

Variable cost     =

$20.00 + (15 + 60) x $10.00 $22.50 per unit

If a batch of 200 is being made the total cost and unit cost are:
Total cost         =              $200 + $22.50 x 200

Unit cost                          $4,700/200        =        $23.50 each

In general:

Total cost  =     fixed cost + variable cost per unit x number of units

Unit cost    =     Total cost-i-number of units


Suppose a process designer has a choice of two methods for making an item. Method A has a fixed cost of $2,000 for tooling and jigs and a variable cost of $3 per unit. Method B requires a special machine cost­ing $20,000 and the variable costs are $ 1 per piece. Let x be the num­ber of units produced.



Method A

Method B

Fixed cost



Variable unit cost



Total cost

$2000.00 + 4*

$10,000.00+ \x

Unit cost

$2000.00 + 4x

SI 0.000.00 +\x




The total cost data in table 1 is shown graphically in figure 4. From table 1 and figure 4, we can see that initially the total cost and unit cost of method A is less than method B. This is because the fixed cost for method B is greater and has to be absorbed over a small number of units. While the total cost for both methods increases as more units are produced, the total cost for method A increases faster until, at some quantity between 2,000 and 3,000 units, the total cost for method B becomes less than for method A. Similarly the unit cost for both meth­ods decreases as more units are produced.

Cost Equalization Point

We would like to know the quantity at which the cost of using method B becomes less than for method A. Knowing this, we could easily de­cide which process to use so the total cost, and the average cost, will be a minimum.

This quantity is called the cost equalization point (CEP) and is the volume where the total cost (and unit cost) of using one method is the same as another. For our example, the total cost calculations are as follows.


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