Fixed cost

Figure 1. A graph showing how the fixed costs stay constant, the variable costs change and the total cost is the sum of the two.[1]
Figure 2. A graph showing how the average fixed cost, the average variable cost change with units produced. Note how the variable cost decreases up to a point, but with more units produced, the average variable cost starts to increase again.[1]

A cost is something that is incurred by a firm, an individual or society while producing or consuming goods and services. It is the consumption of resources such as labour time, capital, materials, fuels, etc. In economics, all resources are valued at their opportunity cost, which is the value of the alternative use of the resources. Costs are defined in a variety of ways and under a variety of assumptions that affect their value. The opposite of a cost is a benefit and often both are considered together. For example, net cost is the difference between gross costs and benefits.[2]

Fixed Cost

Fixed costs are costs that a firm will incur regardless of its output and are sometimes referred to as overhead. These can be costs such as insurance, rent, utilities and others. These costs are incurred even if the company doesn't generate revenue. For example, if a gas station does not open for a whole month it still has to pay its lease rate for the land even though it was not in operation .[3] One way to avoid incurring large costs when production stops is to rid a firm of the things that cause these costs, for example, if a firm has to stop producing and is going to go out of business, to avoid larger rent payments the firm could sublet their real estate space to another firm.

As seen in figure 1, the fixed costs don't change when more units are produced. In contrast, variable cost goes up as more units are produced.

Average Fixed Cost

The average fixed cost (AFC) is simply the fixed cost divided by the quantity produced showing the fixed cost per-unit.

AFC= [math]\frac{FC}{Q}[/math]

This means that the average fixed cost will go down the more units produced (see figure 2). As opposed to average variable cost, which can go down or up with more units produced.

For Further Reading

For further information please see the related pages below:

References

  1. 1.0 1.1 Graph made by a member of the energy education team.
  2. A. Verbruggen, W. Moomaw and J. Nyboer. Glossary of terms used in the: Special Report on Renewable Energy Sources and Climate Change Mitigation (SRREN). [Onlince], Available: http://www.ipcc.ch/publications_and_data/publications_and_data_glossary.shtml [May.29, 2016]
  3. A. Goolsbee, S. Levitt and C. Syverson. Microeconomics. New York: Worth Publishers, 2013, pp. 270.

Authors and Editors

Bethel Afework, Haydon Armstrong, Lyndon G., Jason Donev
Last updated: May 18, 2018
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