For the past 8 months, Jinan Corporation has experienced a steady increase in its cost per unit even though total costs have remained stable. This cost per unit increase may be due to _____________ costs because the level of activity at Jinan is _______________.
- A) fixed, decreasing
- B) fixed, increasing
- C) variable, decreasing
- D) variable, increasing
The correct answer and explanation is:
Correct Answer:
A) fixed, decreasing
Explanation:
Jinan Corporation has experienced a steady increase in its cost per unit, despite total costs remaining stable. This strongly suggests that the company’s fixed costs are being spread over a decreasing number of units, leading to a higher cost per unit.
Understanding Fixed Costs:
Fixed costs remain constant regardless of production levels within a relevant range. These costs include expenses such as rent, salaries of permanent staff, depreciation, and insurance. Unlike variable costs, which fluctuate directly with production, fixed costs are distributed across the total number of units produced.
Impact of Decreasing Activity:
If Jinan Corporation’s level of activity (production or sales volume) is decreasing, fewer units are being produced or sold. Since total fixed costs remain the same, the cost allocated to each unit increases. This results in a rising cost per unit over time.
Example:
Imagine Jinan Corporation has total fixed costs of $100,000 per month.
- If the company produces 10,000 units, the fixed cost per unit is $10.
- If production drops to 8,000 units, the fixed cost per unit increases to $12.50.
Since total costs are stable but cost per unit is rising, we conclude that the decrease in production volume is driving up unit costs. This aligns with option A: fixed costs and decreasing activity levels.
Thus, Jinan Corporation should focus on increasing production or sales volume to distribute fixed costs over a larger number of units and bring cost per unit down.
Generated Image:
A simple illustration showing the relationship between fixed costs, total costs, and decreasing production levels, visually explaining how cost per unit rises.
Generating the image now…
Here’s the generated image illustrating the concept of fixed costs and decreasing production levels. It visually explains how cost per unit rises when production volume decreases. Let me know if you need any modifications!
