Fixed Costs

Fixed Costs


Have you ever heard someone say, “That’s a
fixed cost. There’s nothing we can do about that.” Well, what is a fixed cost exactly? It’s a cost that’s going to remain constant
regardless of any changes in the activity level. By activity level,we’re talking about things
like the number units that the firm produces. So, if the firm produces 50 units instead
of 25, that cost is still going to behave the same. It’s still going to be exactly the same. Let’s just take a really simple example here,
like the cost of a business license. If you want to open a pizzeria and it costs
$500 to get a business license, it doesn’t matter how many pizzas you make throughout
the year. Your units produced doesn’t have any affect
on what this cost is going to be. That cost is always going to be five hundred
dollars. It doesn’t matter whether you make a single
pizza or if you make a thousand. Let’s use a more complicated example. Let’s think about a manufacturing plant that
manufactures trucks. This plant costs $50 million. So, this is a $50 million plant, and let me
actually graph this out and take a look at how the cost behaves. So let’s say that right here is that cost,
and it’s $50 million and the number of units produced (or trucks) we’ll have down here
(that looks like an “a” instead of a “u”) So, that’s our number of trucks. Here’s 10,000 and then we’ve got 20,000 and
then we’ve got 30,000. Now, how is the cost going to behave as the
number love units that we produce changes? Well look, for our factory we could make 10,000
trucks or we can make 30,000. It doesn’t matter, the factory still costs
the same. It’s still $50 million, so the way this is
going to look is we’re just gonna have a flat line. And that line doesn’t look exactly flat, that’s
my fault. So, basically this cost is not changing. Irrespective of how many trucks we make, it
doesn’t change. But if you think about this intuitively for
a moment. What if this went from 10,000 to a million. What if we’re talking about a million trucks? Now all of a sudden we start saying, “Maybe
we actually need to get another factory.” So in that case, this cost although it is
fixed at $50 million. We say, “well it’s fixed within a relevant
range.” What we mean by a relevant range is, lets
say that we think the max amount trucks we can make is 50,000 and we know between 0 to
50,000 the cost is gonna be fifty million. But, if we go beyond 50,000 we can’t accommodate
that our current plant, so we’re actually going to have to build another plant, and
then that’s another $50 million. So the idea being, it’s important to remember
that not all costs are completely fixed. Something like a business license, okay you
are not going to need another business license if you make more pizza than you thought you
were going to. However, some costs that we might think, “oh
a plant that’s fixed” You have to bear in mind…okay fixed, but in what range? If the amount of units that we produce actually
takes off, beyond what our wildest expectations are (maybe down the road), it’s entirely possible
that this cost we thought was fixed might actually behave a little bit differently when
we get outside the relevant range.

6 Comments

  1. Nick Spearnock says:

    First comment

  2. Daniel Levy says:

    These videos are seriously underrated thank you very much.

  3. Carter Tonn says:

    Awesome video, my prof doesn't speak proper english. Learned more in this vid than I've learned in my last 4 classes.

  4. Nugroho Ikhsanul Khuluq says:

    good

  5. Ari Wiejayanto says:

    good information ….

  6. A C says:

    You’re a saint for uploading this playlist. Aspiring accountant here :3

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