History is bunk.                                                                       Sunk costs are sunk.

                Henry Ford                                                                                                                          Anonymous

At least one resource is fixed in the short run, which implies that some short run costs are also fixed. These fixed costs were incurred previously, so they are also known as historical or sunk costs.

 

Fixed costs are the sum of all short-run costs that are not related to the level of output.

 

            For your sand-and-gravel operation, fixed costs would include such things as business licenses, rent you are obligated by a lease to pay, principal and interest on leases for trucks or other equipment, utility hookup charges, and franchise fees. You might be required to make payments during each period, but fixed costs are unaffected by your firm's output.

 

Fixed Costs and Decision Making

Sunk costs should be viewed by managers as irrelevant in making future decisions. For example, suppose that you bought a deluxe mountain bike and were dismayed when its price was slashed 2 weeks later. Then a broken leg persuaded you to sell the bicycle to cover your unexpected medical bills. Of the following, which would be the least relevant to the price you should charge: (a) the price you paid, (b) the current sales price, (c) storage costs, (d) expected enjoyment from riding after you get out of your cast, or (e) the current prices of similar used bikes?

 

            If you chose answer (a) to this question, you intuitively understand the irrelevancy of fixed (or sunk) cost for rational decision making. Many people are astounded when told that fixed costs have no bearing on rational decisions about how much to produce, how much to charge for your output, and so on.

              Fixed costs are meaningful only to the extent that, like history or archaeology, we can learn from them. Since they are fixed, there is a sense in which no alternative exists, so the opportunity costs of fixed resources are zero, at least in the short run. Therefore, only costs that vary with output should affect production decisions in the short run.