Fixed and variable costs
Fixed costs do not change with output in the short run, while variable costs rise and fall with the quantity produced.
Some costs you pay whether you produce anything or not. Others rise and fall with every unit. Telling them apart drives most cost decisions.
Fixed and variable costs are the two basic categories of a firm's costs. Fixed costs do not change with the level of output in the short run, rent, salaries, equipment, while variable costs rise and fall with how much is produced, materials, energy, piece-rate labour. Total cost is simply the two added together.
The short-run dividing line
The split depends on the time horizon. In the short run, some costs are fixed because they are committed: the rent is owed whether the factory runs flat out or stands idle. In the long run, nothing is truly fixed, the lease can end, the plant can be sold, so all costs become variable. The distinction is therefore not about the type of cost in the abstract but about what can be changed within the period in question.
Why the mix shapes behaviour
A firm's balance of fixed and variable costs shapes how it behaves and how risky it is. High fixed costs and low variable costs, typical of airlines, software, and heavy industry, mean each extra unit is cheap to produce, so firms fight hard to fill capacity and may price near variable cost in a downturn. High variable costs mean output can be scaled down cheaply when demand falls. The cost structure determines how a business rides booms and slumps.
The shut-down logic
The distinction underlies one of the sharper short-run decisions: when to keep operating at a loss. A firm should keep producing as long as the price covers its variable costs, even if it cannot cover the fixed ones, because the fixed costs are owed either way and any contribution toward them beats none. Only when price falls below variable cost does producing make the loss worse than shutting down.
Fixed and variable costs are among the first distinctions in cost analysis and among the most practically important. Confusing the two, or forgetting that the line moves with the time horizon, leads firms to mismanage pricing, capacity, and the hard question of when to stop.