Fixed costs

Fixed costs are those costs which, over a given period of time, tend to be unaffected by changes in output. For example, a factory capable of producing 100000 engineering parts in a certain period of time might have fixed costs in terms of rent, heating, lighting and the cost of machinery of £100 000 in that time. If the factory only produces 80 000 units it will still have to meet the costs associated with 100 000 units.

The total number of goods and services a business is capable of producing is known as its capacity. You should realise that businesses offering services will also have a limit to the total amount they can provide for their customers. A hairdressing salon has a given number of seats, sinks, dryers and stylists. A restaurant is limited in the number of meals it can supply by its kitchen capacity, by seating accommodation, the number of staff, and on the number of meals they can serve. The TV engineer is limited by level of skill and the time spent on the number of repairs possible in one day.

When a business produces less than the amount of which it is capable we say it is operating at less than full capacity. This is usually expressed as a percentage of full capacity:

(Number of units produced x 100) / Capacity of business

In the example given above this would be:

(80000 x 100) / 100000 = 80 per cent

Figure 1 Fixed costs Figure 2 Avarege fixed costs declining as output increases

Costs Costs

300 5

200 3

Fixed cost

100 1 Average fixed costs

0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80 90 100

Output Output

Figure1 shows the position of a business with a capacity of 100 000 at a fixed cost of £100 000 in a given period of time.

Average fixed cost is the proportion of total fixed costs carried by each item produced and is calculated by dividing total fixed cost by output. When the business described above is producing at full capacity then the average fixed cost will be £1. When it is operating at 80 per cent capacity the average fixed cost will be £1.20.

Try the same calculation for different levels of output for the above business. You should find that the lower the level of output the higher the average fixed cost. This fact has a significance for businesses when setting prices and deciding whether or not to accept a particular order. Figure 2 shows average fixed costs decreasing as output increases.