Describe how total variable costs and unit variable costs behave with changes in the level of activity.
Total variable costs and unit variable costs are two important concepts in cost analysis that help us understand how costs behave with changes in the level of activity.
Total variable costs refer to the sum of all costs that change in direct proportion to the level of activity. This means that as the level of activity increases, total variable costs also increase, and as the level of activity decreases, total variable costs decrease.
Unit variable costs, on the other hand, refer to the cost per unit of activity. To calculate unit variable costs, you divide the total variable costs by the number of units of activity. It gives you an idea of how much each unit of activity contributes to the total variable costs.
In terms of behavior with changes in the level of activity, both total variable costs and unit variable costs exhibit similar patterns:
1. Total variable costs increase or decrease in direct proportion to changes in the level of activity. If the level of activity doubles, the total variable costs also double. If the level of activity decreases by half, the total variable costs also decrease by half.
2. Unit variable costs remain constant with changes in the level of activity if the costs are truly variable. For example, if a company produces 100 units of a product and incurs total variable costs of $1,000, the unit variable cost would be $1,000 divided by 100 units, which is $10 per unit. If the company produces 200 units next month, the total variable costs would increase proportionally to $2,000. However, the unit variable cost would remain the same at $10 per unit.
It is important to note that these behaviors assume that the costs are truly variable and do not change due to other factors like economies of scale or fixed costs. Therefore, it is essential to analyze the cost behavior carefully before making any assumptions about the relationship between total variable costs, unit variable costs, and changes in the level of activity.
Total variable costs and unit variable costs are both closely related to changes in the level of activity in a business. Here's how they behave:
1. Total Variable Costs: Total variable costs refer to the sum of all costs that change in direct proportion to the level of activity. As the level of activity increases, total variable costs will also increase. Similarly, as the level of activity decreases, total variable costs will decrease as well. This is because variable costs are incurred per unit of activity, such as materials, direct labor, or utilities, and will change in line with the quantity of production.
2. Unit Variable Costs: Unit variable costs, also known as variable cost per unit or variable cost per production unit, represent the cost incurred to produce a single unit of output. Unit variable costs are derived by dividing the total variable costs by the number of units produced. As the level of activity increases, the unit variable costs will generally decrease. This decline occurs because fixed costs, such as overhead or rent, are spread over a larger number of units, reducing the overall cost per unit. Conversely, as the level of activity decreases, unit variable costs will rise, as fixed costs are now divided among a smaller quantity of units.
In summary, total variable costs will increase or decrease in direct proportion to changes in the level of activity, while unit variable costs will decrease when the level of activity increases and increase when the level of activity decreases.