Fixed Cost

A fixed cost is a cost that remains constant, in total, regardless of changes in the level of activity. Unlike variable costs, fixed costs are not affected by changes in activity. Consequently, as the activity level rises and falls, the fixed costs remain constant in total amount unless influenced by some outside force, such as price changes. Rent is a good example of a fixed cost. Suppose a hospital rents a machine for £ 8, 000 per month that tests blood samples for the presence of leukaemia cells. The £ 8, 000 monthly rental cost will be sustained regardless of the number of tests that may be performed during the month. The concept of a fixed cost is shown in graphic form in Exhibit 2.9.

Very few costs are completely fixed. Most will change if there is a large enough change in activity. For example, suppose that the capacity of the leukaemia diagnostic machine at the hospital is 2, 000 tests per month. If the clinic wishes to perform more than 2, 000 tests in a month, it would be necessary to rent an additional machine, which would cause a jump in the fixed costs. When we say a cost is fixed, we mean it is fixed within some relevant range. The relevant range is the range of activity within which the assumptions about variable and fixed costs are valid. For example, the assumption that the rent for diagnostic machines is £ 8, 000 per month is valid within the relevant range of 0 to 2, 000 tests per month.

Fixed costs can create difficulties if it becomes necessary to express the costs on a per unit basis. This is because if fixed costs are expressed on a per unit basis, they will react inversely with changes in activity. In the hospital, for example, the average cost per test will fall as the number of tests performed increases. This is because the £ 8, 000 rental cost will be spread over more tests. Conversely, as the number of tests performed in the clinic declines, the average cost per test will rise as the £ 8, 000 rental cost is spread over fewer tests. This concept is illustrated in the table below:

Summary of variable and fixed cost behaviour