A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses that have to be paid by a company, independent of any business activity. It is one of the two components of the total cost of a good or service, along with variable cost. Fixed costs are costs that are independent of output. These remain constant throughout the relevant range and are usually considered sunk for the relevant range (not relevant to output decisions). Fixed costs often include rent, buildings, machinery, etc. Fixed costs are costs that do not change when the quantity of output changes. Unlike variable costs, which change with the amount of output, fixed costs are not zero when production is zero.
An example of a fixed cost would be a company's
lease on a building. If a company has to pay $10,000 each month to cover the
cost of the lease but does not manufacture anything during the month, the lease
payment is still due in full.
In economics, a business can achieve economies of scale when it produces enough
goods to spread fixed costs. For example, the $100,000 lease spread out over
100,000 widgets means that each widget carries with it $1 in fixed costs. If
the company produces 200,000 widgets, the fixed cost per unit drops to 50 cents
Some examples of fixed costs include
rent, insurance premiums, or loan payments. Fixed costs can create economies of scale, which are reductions
in per-unit costs through an increase in production volume.
This idea is also referred to as diminishing marginal cost. For example,
let's assume it costs Company XYZ $1,000,000 to produce 1,000,000 widgets per year ($1 per widget). This $1,000,000
cost includes $500,000 of administrative, insurance, and marketing expenses,
which are generally fixed. If Company XYZ decides to produce 2,000,000 widgets
next year, its total production costs may only rise to $1,500,000 ($0.75 per
widget) because it can spread its fixed costs over more units. Although Company
XYZ's total costs increase from $1,000,000 to $1,500,000, each widget becomes
less expensive to produce and therefore more profitable.Some fixed costs change
in a stepwise manner as output changes and therefore may not be totally fixed.
Also note that many cost items have both
fixed and variable components. For example, management salaries typically do
not vary with the number of units produced. However, if production falls
dramatically or reaches zero, layoffs may occur. Economically, all
costs are variable in the end.