fixed cost and variable cost

Run any business and your costs split into two kinds. Some you pay no matter how much you sell — the rent on the shop, the insurance, the loan repayment on the oven — these are there even on a day you sell nothing. Others go up and down with how much you make — the flour, the electricity to run the oven, the wages of staff you hire by the hour. The first kind are fixed costs; the second are variable costs.

Fixed costs do not change with output in the short run: bake one loaf or a thousand, the rent is the same. Variable costs rise as you produce more: a thousand loaves needs far more flour than one. So total cost = fixed cost + variable cost. Here is the consequence that drives so many business decisions: because the fixed cost is spread over however many units you sell, the fixed cost per loaf falls as you sell more. Selling 10 loaves means each carries a tenth of the rent; selling 1,000 means each carries a thousandth. That 'spreading the overhead' is why bigger output often feels cheaper per unit.

The split is the backbone of cost analysis and of real decisions. It tells a shop how many it must sell just to cover the rent (the break-even point), and it explains the cruellest short-run choice of all: on a bad day a firm should keep trading as long as the price covers its variable costs, because the fixed costs must be paid whether it opens or not. Crucially, the fixed/variable line is a short-run idea — give it long enough and even the rent can be renegotiated or the lease dropped, so in the long run all costs are variable.