Chapter 4, Problem 1RQ

Fixed costs are often defined as “fixed over the short run.” Does this mean that they are not fixed over the long run? Why or why not?

To determine

Comment on the given statement about the nature of fixed costs.

Explanation of Solution

Fixed cost:

Fixed cost does not vary with the change in the production of the goods. It stays the same at the various level of output. Generally, fixed cost is not output-related; it is time-related.

“Fixed over short run”:

The short run has a time-span of 12 months or less than 12 months.  Generally, fixed cost remains fixed over the short run of business.  Insurance, rent, interest, taxes, and depreciation are the fixed cost of the business, and these costs do not change in the short run of business. But this does not mean that they are fixed over the long run of the business. Fixed cost may remain fixed or may change in the long run. It depends on the course of activity and management decision.

Example:

A business may choose to relocate its plant from location A to location B after five years. Location B has higher rent then location A. This will lead to the change in fixed cost as business has to pay higher rent in location B. If the management does not choose to relocate then the fixed cost will not change.

Thus, the fixed cost remains fixed in the short run, but it may or may not vary in the long run depending upon the course of activity and decisions of management.