Chapter 5 Notes
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This definition of Fixed Costs is possible because two assumptions have been made.
First, the time horizon being discussed is relatively short.
Second, the range of
production in question is limited.
The time horizon is important.
In making decisions, we typically assume a relatively
short time horizon.
For example, we might be considering a time horizon of one year.
Over that year, our rent is likely to remain unchanged regardless of a change in the
level of our production.
Over a long enough time horizon, however, all costs become
For example, with a longer time horizon, our monthly rental expense is likely
to increase due to the expiration of our lease, an expansion of our operations, and/or
the need to increase and modernize our production capacity.
In addition to the time horizon, we also typically assume that we will be operating within
a range of activity (Relevant Range).
For example, assume that our baseball bat
manufacturer normally produces and sells between 10,000 and 20,000 bats in a year,
and it has the capacity to make up to 40,000 bats in its current facilities.
In this case, it
is unlikely that it will be called upon to make more than 40,000 bats, and it is unlikely
that its Fixed Costs will change within this Relevant Range of production (10,000 –
Without the assumption regarding Relevant Range, the Fixed Cost function could