Question

Are fixed costs also sunk costs? Explain.

Short answer

No, fixed costs are not sunk costs. Although both may be constant, fixed costs, such as rent or salaries, are recurring and considered in future decision-making. In contrast, sunk costs, like advertising expenses, have already been incurred, cannot be recovered, and should not be considered in future decisions.

Step-by-step solution

Fixed costs definition

Fixed costs are expenses that do not change based on the volume of output or production. They are typically recurring costs, such as rent, salaries, or insurance, among others. In other words, these costs are incurred regardless of the level of production.

Sunk costs definition

Sunk costs are costs that have already been incurred and cannot be recovered or altered. These costs are not considered when making future decisions, as they have no impact on upcoming costs or profits. Examples of sunk costs include advertising expenses, research and development expenditures, and investments in non-transferable specialized equipment.

Comparing fixed costs and sunk costs

Though both fixed costs and sunk costs can be constant, they differ in that fixed costs are still relevant in decision-making processes, while sunk costs are not. Fixed costs are recurring, whereas sunk costs have already been spent and cannot be recovered.

Are fixed costs sunk costs?

No, fixed costs are not sunk costs. While both may be constant, fixed costs are considered in future decision-making and recur over time, while sunk costs have already taken place and should not factor into future decisions.

Examples to clarify the difference

To further illustrate the difference between fixed costs and sunk costs, consider the following example: A company manufactures a product, and their fixed cost is the monthly rent for their manufacturing facility. This cost remains the same regardless of the number of products produced and must be paid every month. On the other hand, the company invested in a marketing study that took place before product production. This cost is unrecoverable and should not be taken into account when determining future profits or expenses. Therefore, this marketing study cost is considered a sunk cost. In conclusion, fixed costs are not the same as sunk costs, as they have different implications in a company's decision-making process, with fixed costs being taken into account in future decisions and sunk costs being ignored.