Question

Are fixed costs also sunk costs? Explain.

Short answer

No, fixed costs are not always sunk costs. Fixed costs are ongoing, regular expenses that remain constant regardless of the level of production or sales, whereas sunk costs are expenses that have been spent and cannot be altered or recovered. Some fixed costs can become sunk costs in certain situations, such as a company locked into a long-term lease that cannot be canceled. However, in general, fixed costs and sunk costs are separate economic concepts with distinct implications for business operations and decision-making.

Step-by-step solution

Define Fixed Costs

Fixed costs are the expenses that a company has to pay regardless of its level of production or sales. They do not change with variations in output levels and are often considered as unavoidable expenditures. Examples of fixed costs include rent, salaries, insurance, and depreciation.

Define Sunk Costs

Sunk costs are the expenses that have already been incurred and cannot be recovered or changed. These costs are typically not taken into consideration when making decisions for the future as they have already been incurred and cannot be altered. Examples of sunk costs include advertising campaigns, research and development expenses, and one-time startup costs.

Comparing Fixed Costs and Sunk Costs

While fixed costs and sunk costs may seem similar, they are different in their nature and how they affect decision-making. Fixed costs are a part of regular business operations and remain constant irrespective of the level of production or sales, whereas sunk costs are costs that have already been spent and cannot be recovered or changed. Fixed costs contribute to determining the break-even point for a business, while sunk costs do not have any impact on future decisions as they cannot be altered.

Are Fixed Costs Sunk Costs?

Based on the definitions and comparisons, we can conclude that fixed costs are not always sunk costs. Fixed costs are ongoing, regular expenses that remain constant, whereas sunk costs are expenses that have been spent and cannot be altered or recovered. However, it is important to note that some fixed costs can become sunk costs if, for example, a company is locked into a long-term lease or contract that cannot be canceled even if the company ceases operations. But in general, fixed costs and sunk costs are separate economic concepts with distinct implications for business operations and decision-making.