Economics Homework Help

Question: Give an example of a business with a high fixed cost. What are the pros and cons of running a business with high fixed costs instead of high variable costs?

Costs of running a business can be divided into fixed costs and variable costs. Fixed costs as the name indicates, remain the same whatever quantity of goods and services are produced.

Reply:

Student 1

A great example of companies with high fixed costs is airlines. An airline incurs almost the exact costs of flying one person or 200 people from place A to place B; the only variable is the extra fuel for the weight difference due to the number of passengers and luggage. The staff and airport fees are all fixed costs per flight. In 2020 due to COVID-19, many airlines received aid from the government to keep functioning. The International Air Transport Association (IATA) downgraded its revenue outlook for next year because of the slow recovery from the coronavirus pandemic. Governments are closing borders and implementing other travel restrictions as infections surge at a record pace in Europe and the U.S. The industry association forecast 2021 airline revenues will be 46% lower than the $838 billion achieved in 2019 compared to a 29% contraction in its previous analysis. (Kulisch, 2020)

Being an aircraft owner or having a private flight company also demands high fixed costs as aircraft maintenance, insurance, and hangar rental. Since the very beginning of the pandemic, the flight industry was shot down and highly restricted, which led to the Airlines laying off thousands of employees seeking a reduction on its fixed costs. As opposed to variable costs, fixed costs are defined as costs that remain the same. Conversely, variable costs are subject to change and include fuel, oil, maintenance, landing fees, etc. An aircraft’s fixed costs remain the same no matter how many hours you fly your plane. However, the “cost per unit” of a fixed cost will increase (or decrease) depending on the level of activity of the airplane. (Houston, 2019)

I believe covid 19 is a clear example of why a company wants to keep its fixed costs as low as possible. As we all saw, the pandemic hit hard the airline industry. In January 2021, Alaska airlines released its full-year results for 2020. They reported that by eliminating fuel expense and certain special items from their unit metrics, they have better visibility into the effects of operations as they focus on cost-reduction initiatives emerging from the COVID-19 pandemic. The industry is highly competitive and holds high fixed costs, so a slight reduction in non-fuel operating costs can significantly improve operating results. In addition, they believe that all domestic carriers are similarly impacted by changes in jet fuel costs over the long run, so management must understand the impact of company-specific cost drivers such as labor rates and productivity, airport costs, maintenance costs, etc. are controllable by management. (AlaskaAirlines, 2021)

References

AlaskaAirlines. (2021, January 26). Alaska Air Group reports fourth quarter 2020 and full-year results. Retrieved from newsroom.alaskaair.com: https://newsroom.alaskaair.com/2021-01-26-Alaska-A…

Houston, S. (2019, December 9). The Fixed Costs Attached to Aircraft Ownership. Retrieved from www.thebalancecareers.com: https://www.thebalancecareers.com/aircraft-ownersh…

Kulisch, E. (2020, October 27). Fixed costs to sink airlines unless governments intervene, IATA warns. Retrieved from www.freightwaves.com: https://www.freightwaves.com/news/fixed-costs-to-sink-airlines-unless-governments-intervene-iata-warns

Student 2

by Mario Salge Mata on Monday, November 15, 2021, 11:44 PM

Number of replies: 3

First, let’s define the idea of a fixed cost; refers to an expense that a company has to incur no matter the fluctuation in other variables, in other words, “refers to a cost that does not change with an increase or decrease in the number of goods or services produced or sold.” (Hayes, 2021) A real-life example of one of the most common businesses with a high fixed cost is airline companies or cruise ships. These costs are set over a specified period of time and do not change with production levels. Airlines would have to keep paying for the fuel, the crew’s wages onboard, plus all the staff inside the airport no matter the number of seat tickets they have sold until that date. “If fixed costs are high, a company will find it difficult to manage short-term revenue fluctuation because expenses are incurred regardless of sales levels.” (McClure, 2021) In other words, one of the cons that would affect airlines’ performance and investment is the difficulty of producing revenue in the short term. Besides, the high risk attached to the acquisition of high fixed cost companies struggles to find investors and capital at low rates. companies with high operating leverage are also vulnerable to sharp economic and business cycle swings. (McClure, 2021) On the other hand, one of the advantages of high fixed costs is riskier. It does mean that every sale made after the break-even point will generate a higher contribution to profit. they are very profitable companies in the long run as long as resources are well managed and strategy is applied.

References:

Hayes, A. (2021, November 11). Fixed cost definition. Investopedia. Retrieved November 12, 2021, from https://www.investopedia.com/terms/f/fixedcost.asp.

McClure, B. (2021, September 13). How operating leverage can impact a business. Investopedia. Retrieved November 12, 2021, from https://www.investopedia.com/articles/stocks/06/op…

1. Offer at least two 200-300-word comments (replies) to posts from your peers’ discussions by Sunday 11:55 pm to earn a maximum of 8 points each