Definition: The Fixed Cost is the cost that remains fixed for a certain volume of output. In other words, the cost that does not change with the change in the output or sales revenue, i.e. it remains fixed irrespective of the volume of output is called the fixed cost.
The concept of fixed cost is associated with the short run since all the costs vary over time, and no cost remains purely fixed for a longer period. It mainly includes the cost of administrative or managerial staff, depreciation of land, building, machinery and other fixed assets, maintenance cost, etc. The firm has to pay these costs irrespective of its level of production.
For example, the fixed cost would be the company’s rent of the machine. Suppose a firm uses a certain machine on rent then it is required to pay rent every month, even if the machine was left idle at any point in time. Thus, the amount of rent paid every month is fixed that a firm has to incur irrespective of the usage of the machine.
The company with a relatively larger fixed cost fear fall in the profit margins, if the sales decline and conversely, if the sales increase the firm realizes higher profit margins as each additional revenue generated covers the constant cost level. Thus, the fixed cost is essential for projecting the profits and calculating the break even point of business or project.
Also, the high fixed costs discourage the new entrants from entering the market, thereby limiting the competition.