fixed cost

Examples of fixed cost in the following topics:

• Fixed Costs

  • By definition, there are no fixed costs in the long run.
  • Discretionary fixed costs usually arise from annual decisions by management to spend on certain fixed cost items.
  • Average fixed cost (AFC) is an economics term that refers to fixed costs of production (FC) divided by the quantity (Q) of output produced .
  • Average fixed cost is a per-unit-of-output measure of fixed costs.
  • This graph breaks down the difference between fixed costs and variable costs.

• Types of Costs

  • It consists of variable costs and fixed costs.
  • Total cost is the total opportunity cost of each factor of production as part of its fixed or variable costs .
  • However, fixed costs are not permanent.
  • Economic cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity costs.
  • This graphs shows the relationship between fixed cost and variable cost.

• Leverage Models

  • Operating leverage models include ratios, such as fixed costs to variable costs/total costs, fixed costs to income, and the DOL.
  • The total fixed costs are $1,000.
  • Just as we interpret ratios of debt to equity and debt to total assets when analyzing financial leverage, when analyzing operating leverage, we can compare fixed costs to variable costs and fixed costs to total costs.
  • Thus, for a given level of sales and profit, the DOL is higher when fixed costs are higher.
  • Operating leverage is equal to total fixed costs divided by operating income.

• Defining Operating Leverage

  • Specifically, it is the use of fixed costs over variable costs in production.
  • For example, replacing production workers (variable cost) with robots (fixed cost) .
  • As operating leverage increases, more sales are needed to cover the increased fixed costs.
  • These include the ratio of fixed costs to total costs, the ratio of fixed costs to variable costs, and the Degree of Operating Leverage (DOL).
  • The ratios of fixed cost to total costs and fixed costs to variable costs tell us that if the unit variable cost is constant, then as sales increase, operating leverage decreases.

• Costs and Production in the Short-Run

  • Fixed Cost (FC) is the quantity of the fixed input times the price of the fixed input.
  • FC is total fixed cost and may be referred to as TFC.
  • Average Fixed Cost (AFC) is the FC divided by the output or TP, Q, (remember Q=TP).
  • AFC is fixed cost per Q.
  • Remember that fixed cost do not change and therefore do not influence MC.

• Economic Costs

  • So, the economic cost of college is the accounting cost plus the opportunity cost.
  • Total cost (TC): total cost equals total fixed cost plus total variable costs (TC = TFC + TVC) .
  • Fixed cost (FC): the costs of the fixed assets (those that do not vary with production).
  • Average fixed cost (AFC): the fixed costs divided by output (AFC = TFC/q).
  • The average fixed cost function continuously declines as production increases.

• Natural Monopolies

  • The total cost of the natural monopoly is lower than the sum of the total costs of two firms producing the same quantity .
  • Natural monopolies tend to form in industries where there are high fixed costs.
  • A firm with high fixed costs requires a large number of customers in order to have a meaningful return on investment.
  • As it gains market share and increases its output, the fixed cost is divided among a larger number of customers.
  • For both of these, fixed costs of building the necessary infrastructure are high.

• Production Outputs

  • Fixed costs are those expenses that remain constant regardless of the amount of good that is produced.
  • Variable costs are only those expenses that are directly tied to the production of more units; fixed costs are not included.
  • If the manufacturer stopped production, it would sustain all the fixed costs as a loss.
  • The revenue gained from sales of these products do not offset variable and fixed costs.
  • If it does not produce goods, the firm suffers a loss due to fixed costs, but it does not incur any variable costs.

• Average and Marginal Cost

  • Marginal cost is the change in total cost when another unit is produced; average cost is the total cost divided by the number of goods produced.
  • Marginal cost is not related to fixed costs.
  • It is also equal to the sum of average variable costs and average fixed costs.
  • When the average cost declines, the marginal cost is less than the average cost.
  • When the average cost increases, the marginal cost is greater than the average cost.

• Short Run and Long Run Costs

  • Long run costs have no fixed factors of production, while short run costs have fixed factors and variables that impact production.
  • In the long run there are no fixed factors of production.
  • Fixed costs have no impact of short run costs, only variable costs and revenues affect the short run production.
  • Examples of variable costs include employee wages and costs of raw materials.
  • The main difference between long run and short run costs is that there are no fixed factors in the long run; there are both fixed and variable factors in the short run .