Fixed Cost

Fixed costs must be paid whether sales are high or low. Common examples include rent, insurance, salaries of permanent staff, loan interest and depreciation of equipment.

For example, a bakery paying rent of 5,000 a month pays the same 5,000 whether it bakes 1,000 loaves or 10,000.

Because fixed costs do not rise with output, the fixed cost per unit falls as production increases. At 1,000 loaves, rent costs 5 per loaf; at 10,000 loaves, it costs only 0.50 per loaf. This is one reason larger production volumes can lower costs per unit.

Fixed costs are not fixed forever. Over longer periods or larger changes in scale, they can change: a business may need a bigger building or more managers if it grows significantly. That is why they are described as fixed only within a relevant range of activity.

Businesses with high fixed costs, such as airlines, factories and software companies, have high operating leverage. Their profits rise quickly when sales grow, because most extra revenue falls straight to profit, but fall quickly when sales decline, because costs cannot easily be cut.