Average Fixed Cost vs Sunk Cost
Average Fixed Cost and Sunk Cost are two Production & Costs concepts in AP Economics that students often mix up. Average Fixed Cost is the fixed cost per unit of output produced. A sunk cost is a cost that has already been incurred and cannot be recovered. Here is how they compare side by side.
It is found by dividing total fixed cost by quantity of output. Since fixed costs do not change with output, average fixed cost continuously declines as output increases.
Sunk costs should not influence future economic decisions because they are irreversible. Rational firms ignore sunk costs when deciding whether to continue production or shut down, focusing instead on marginal costs and revenues.
Average Fixed Cost vs Sunk Cost: Per Unit vs Unrecoverable
| Average Fixed Cost | Sunk Cost | |
|---|---|---|
| The test being applied | Does the cost change when output changes? | Can any of it be recovered? |
| Level of the figure | Per unit of output, at a stated quantity | A lump already spent |
| As output rises | Falls toward zero | Unaffected; output is beside the point |
| Do the two coincide? | Only when the fixed cost cannot be escaped | Not always; custom material already cut was a variable cost and is now sunk |
| Role in the shutdown rule | Left out of the comparison, but it sets the size of the loss | Left out of every comparison, always |
| In the long run | Gone, since every input can be adjusted | Still possible; money spent on a failed prototype stays spent |
| On a diagram | A falling curve, and the gap between ATC and AVC | No curve; it appears in the wording of the stem |
Two firms with identical average fixed cost can have completely different sunk costs
Average fixed cost comes off the cost table; whether that money is sunk depends on facts the table cannot show. Put two firms side by side, each with fixed costs of 60 a month and each producing 40 units, so each has average fixed cost of 1.50. The first rents its machine month to month and can hand it back with no penalty. The second bought a custom machine that no other buyer wants. The cost curves are identical and the decisions are not: the first firm's fixed cost is avoidable, so walking away costs it nothing, while the second firm's spending is gone whatever it does next. Partial cases are the ones that trip students up. If the custom machine could be resold for 24, then 36 is sunk and 24 is not, and continuing to use the machine carries an opportunity cost of the 24 the firm turns down by not selling it. The recoverable slice belongs in the decision and the unrecoverable slice never does, however large it looms.
The shutdown rule quietly assumes the fixed cost is sunk
Ignoring fixed costs when deciding whether to keep operating is only correct because the standard problem treats them as unavoidable. Take the firm above at 40 units with a price of 5, average variable cost of 4 and average total cost of 5.50. Revenue is 200, variable cost is 160 and total cost is 220, so operating loses 20. Shutting down does not get to zero: production stops, revenue stops, and the 60 is still owed, so the loss becomes 60. Losing 20 by operating beats losing 60 by closing, which is exactly what price above average variable cost means. Now change one fact. Make the lease cancellable, so the 60 disappears the moment the firm stops. Closing costs nothing, operating still costs 20, and the right answer flips even though every curve on the diagram is unchanged. Average fixed cost still earns its keep elsewhere: it is the vertical gap between the two average curves, and it is why the loss is 20 rather than nothing. The arithmetic is at /calculate/average-fixed-cost and /calculate/average-total-cost.
Frequently asked questions
Are fixed costs always sunk costs?
No. A fixed cost is one that does not move with output, while a sunk cost is one that cannot be recovered. Rent on a lease you can cancel is fixed but not sunk, and a batch of custom parts already cut to size was a variable cost that is now sunk. The two labels answer different questions, and a stem that mentions resale value or a cancellable contract is usually testing this distinction.
Why are sunk costs irrelevant to a decision?
Because the same amount is gone under every option, so it cannot break the tie between them. Spending 60 on a machine with no resale value leaves the firm choosing between operating and closing with that 60 already lost either way, and only the differences between options should decide. Producing on to justify money already spent is the sunk cost fallacy, which appears on exams as a firm clinging to a losing product line.
Does average fixed cost affect the shutdown decision?
No. The short-run test compares price with average variable cost, and average fixed cost sits out of that comparison entirely. What average fixed cost controls is the size of the loss and the vertical distance between average variable cost and average total cost. It does drive the long-run decision, since a firm that cannot cover average total cost eventually exits rather than merely pausing production. See /micro/production-costs for both rules in one place.
Live Production Costs graph. Drag the curves, or open the full version.
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