Question

When setting prices, what is the difference between how you would take into account an incremental fixed cost and how you would take into account a fixed cost that is not incremental?

Answer 1

Costs that do not change between alternatives are not relevant in managerial decision making. Setting prices involves managerial decision making.

Therefore, in setting prices, fixed costs that are not incremental are not relevant, as they are already allocated to current volume of production and sales, and the total amount will not change with further increase in volumes.

However, incremental fixed costs are those which would increase with increase in volumes from the current levels. These are relevant fixed costs, as these would be avoidable if the decision is not taken. These fixed costs would be added to the variable costs before setting the price.