Consider the following costs of owning and operating a car....

Consider the following costs of owning and operating a car. A $¥ 2,300,000$ Toyota RAV4 financed over 48 months at 4 percent interest means a monthly payment of approximately $¥ 52,000$. Insurance costs $¥ 20,000$ a month regardless of how much you drive. The car gets $30 \mathrm{~km}$ per liter and uses regular-grade gasoline that costs $¥ 400$ per liter. Finally, suppose that wear and tear on the car costs about $¥ 5$ per km. Which costs are fixed, and which are variable? What is the marginal cost of a kilometer driven? In deciding whether to drive from Tokyo to Kyoto (about $900 \mathrm{~km}$ round-trip), which costs would you consider? Why?

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Key Concepts

Fixed Costs

Fixed costs are expenses that do not change with the level of activity over a given period. In car ownership, items like the loan payment for financing the car and the monthly insurance premium remain constant, regardless of how much you drive, making them fixed costs.

Variable Costs

Variable costs fluctuate directly with the level of use or activity. For a car, these include costs like fuel consumption and wear and tear, which increase as the distance driven increases, making them clearly variable.

Marginal Cost

Marginal cost is the additional cost incurred by operating one extra unit, in this case, driving one additional kilometer. It is calculated by adding the per-kilometer fuel cost (derived from the car’s fuel efficiency and fuel price) and the per-kilometer wear and tear cost.

Relevant Costs

Relevant costs are the expenses that will change as a result of a particular decision. When deciding whether to take a long trip, only the incremental or variable costs (like fuel and maintenance) should be taken into account, as fixed costs are already incurred and do not impact the decision to drive further.

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