In the short-run, a firm employs two types of factors: fixed factors and variable factors. Costs are also of two types: fixed costs and variable costs.

Fixed Costs – Fixed costs (also known as supplementary costs or overhead costs) are the costs that do not vary with the output. These are the expenses incurred on the fixed factors of production.

Examples: Rent; interest; insurance premium; salaries of permanent employees, etc.

Variable Costs – Variable costs (or prime costs) are the costs that vary directly with the output. These are the expenses incurred on the variable factors of production.

Examples: Expenses on raw materials, power and fuel; wages of daily labourers, etc.