How Stuff Works: Variable Costs

Today in our occasional series on How Stuff Works I thought it might be helpful to explain what variable costs are and how they differ from fixed costs. It’s one of those concepts that isn’t really as simple as the people from Accounting like to make it sound, and even people who really should know better can often get tripped up by the difference – as is being illustrated in Georgia right now, where the recent change in immigration law has driven off all of the undocumented workers who used to find employment in the summer picking crops. People on the pro-immigrant side are claiming that the crops will be lost because no one else will be willing to do these jobs, while those on the anti-immigrant side are saying that labor costs have never represented more than 10% of the total cost we pay for produce, so any change in who harvests the crops shouldn’t matter. I look at this and point out that both sides appear to know more about politics than they do about economics…

To begin with, the contention that no one will harvest crops except for undocumented workers is nonsense; it would be more correct to say that no one else will do these jobs for the horrific wages normally offered. But if you raise the hourly rate enough, eventually people will agree to do the job; try offering people $100 an hour, for example, and see if people are willing to tend the fields for the equivalent of $365,000 per year. Wages are an example of a variable cost: the amount it costs the company varies depending on how many people you employ and the rate at which you pay them, which in turn varies on the amount of work that must be done, how much of it each worker can do in an hour, and how much money people are willing to accept in return for that labor. In the case of agricultural firms, most of the other costs are set, or fixed, in advance: the mortgage on the land, the property tax you pay, the cost of the equipment (if any) and so on are all known well in advance; only consumables like water, fertilizer and seeds will vary depending on what you want to grow (and how much of it) – as will the number of people you need to accomplish these tasks…

On the other hand, the contention that labor costs have never made up more than 10% of the price you pay for produce at the supermarket is just as silly. People can’t live without food; if your grocery bill suddenly rises you may cut back in other areas (entertainment, travel, other consumer products) and you might write to your government officials, but you can’t just stop buying food. But, by the same token, farmers need to make enough money selling their crops in order to pay their own costs and feed their own families, which means that if their labor costs suddenly double, they will have to pass the increase in price along to the buyer – which ultimately means the consumer. It’s possible to estimate variable costs from past experience: in this case, labor has usually made up about 10% of the costs involved in raising food crops. But if the price of labor were to suddenly drop – if there were no jobs, no welfare programs, no safety nets, and no other way to make a living, or of somebody invented a series of really inexpensive robots that could do the same jobs for less than an unskilled worker’s wages – then those historical projections would be meaningless. And if the price of labor were to suddenly rise – say, if some idiot drove off all of the people who were willing to work for a certain low wage level – then the historical pricing information would also be useless…

Personally, I’ve always felt that the contention that foreigners were coming into this country to take away jobs from those hypothetical “hard-working Americans” was xenophobic, racist, protectionist crap, but I’ll admit I’m no expert on either politics or agriculture. I do, however, have two graduate degrees in Business, and I’m fairly sure that the people who passed this so-called “Immigration Reform” act in a state where the largest industry is Agriculture weren’t thinking things through – and that people on both sides of this issue appear to be unclear on the concept of variable costs. Hopefully, the rapid influx of cheaper produce from states (and countries) that still have cheap agricultural labor forces will help explain the difference – or at least stabilize food prices before there are riots in the streets…