A variable cost is a cost that varies per unit of product, whereas a fixed cost is constant per unit of product. Do you agree? Explain.
The correct answer and explanation is :
No, I do not agree with the statement. The definition given for variable and fixed costs is incorrect.
A variable cost is a cost that changes in total with the level of production or sales volume. It varies in direct proportion to the number of units produced or sold. However, the cost per unit of a variable cost typically remains constant. Examples of variable costs include raw materials, direct labor (if paid per unit), and sales commissions.
A fixed cost, on the other hand, is a cost that remains constant in total regardless of changes in production volume within a relevant range. However, the cost per unit of a fixed cost decreases as production increases and increases as production decreases. Examples of fixed costs include rent, salaries of permanent employees, and insurance.
Explanation
The key mistake in the statement is the definition of how these costs behave per unit.
- Variable Costs: These costs change in total with production but stay the same per unit. For example, if raw materials cost $5 per unit, the total cost increases with more production (e.g., 100 units cost $500, 200 units cost $1,000). However, the cost per unit remains at $5.
- Fixed Costs: These costs remain the same in total but change per unit. For example, if rent is $10,000 per month, it remains $10,000 whether the company produces 1,000 or 2,000 units. However, the cost per unit decreases as more units are produced. If 1,000 units are made, the rent per unit is $10 ($10,000 ÷ 1,000). If 2,000 units are made, the rent per unit drops to $5 ($10,000 ÷ 2,000).
Thus, the correct explanation is that variable costs remain constant per unit but vary in total, while fixed costs remain constant in total but vary per unit.