What effect does an increase in the activity level have on average fixed costs per unit

In economics, average fixed cost (AFC) is the fixed costs of production (FC) divided by the quantity (Q) of output produced. Fixed costs are those costs that must be incurred in fixed quantity regardless of the level of output produced.

Average fixed cost is fixed cost per unit of output. As the total number of units of the good produced increases, the average fixed cost decreases because the same amount of fixed costs is being spread over a larger number of units of output.

Average variable cost plus average fixed cost equals average total cost:

Explanation[edit]

Example 1[edit]

Assume a firm produces clothing. When the quantity of the output varies from 5 shirts to 10 shirts, fixed cost would be 30 dollars.[1] In this case, average fixed cost of producing 5 shirts would be 30 dollars divided by 5 shirts, which is 6 dollars. In other words, when 5 shirts are produced, 30 dollars of fixed cost would spread and result in 6 dollars per shirt. Similarly, average fixed cost of producing 10 shirts would be 3 dollars derived from 30 dollars divided by 10 shirts.

A table and graph of average fixed cost

Example 2[edit]

In Example1, there was no information about average total cost and average variable cost. If the firm knows average total cost and average variable cost, it is possible to find the same result as Example 1. Because average total cost is average variable cost plus average fixed cost, average fixed cost is average total cost minus average variable cost.[2] If producing 5 shirts generates average total cost of 11 dollars and average variable cost of 5 dollars, fixed cost would be 6 dollars. Similarly, the firm produces 10 shirts and average total cost and average variable cost is 10 dollars and 7 dollars respectively. In this case, average fixed cost would be 3 dollars.

See also[edit]

• Average variable cost
• Average cost

Reference[edit]

1. ^ Dorman, Peter (2014). "Production Costs and the Theory of Supply". Microeconomics. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. pp. 249–274. doi:10.1007/978-3-642-37434-0_12. ISBN 9783642374333.
2. ^ "AmosWEB is Economics: Encyclonomic WEB*pedia". www.amosweb.com. Retrieved 2018-03-06.

Types of Costs as to Behavior

Costs, when categorized according to behavior (in relation to changes in level of activity), can be classified into: (1) fixed costs and (2) variable costs.

Variable Costs

Within a relevant range and specified time period, the total variable costs vary directly (in proportion) to the change in activity level. The cost per unit is constant.

For example: ABC Company spends $2.50 materials cost for every unit of Product A. If the company produces 1,000 units, it spends $2,500 ($2.50 x 1,000). If it produces 2,000 units, then the company will spend $5,000 ($2.50 x 2,000). Take note that the cost per unit does not change but the total cost varies directly with the level of activity.

Total variable cost = Variable cost per unit x Number of units or activity

Common examples of variable costs include direct materials, direct labor, supplies, fuel and power, spoilage costs, receiving costs, royalties, overtime premium, sales commissions, and delivery expenses.

Fixed Costs

Within the relevant range, total fixed costs remain constant. Regardless of the level of activity, the business pays the same. However, the fixed cost per unit changes as the level of activity changes. As more units are produced, the fixed cost per unit decreases.

For example: ABC Company pays monthly rent of $30,000 for a factory building. Regardless of how many units are produced, the company pays the same amount. If we are to compute for the fixed cost per unit at 1,000 units, it would be equal to $30 ($3,000/1,000 units). If the company produces 1,500 units, then fixed cost per unit would be $20 ($3,000/1,500 units). As the level of activity increases, the fixed cost per unit decreases. The total fixed cost remains the same.

Examples of fixed costs include rent, depreciation, patent amortization, property insurance, property taxes, and fixed salaries of production executives and indirect labor.

Mixed Costs

Mixed costs contain both fixed and variable elements. The company pays a constant fixed cost and a variable amount on top of it. Examples of mixed costs include: utilities, repairs and maintenance, inspection, fringe benefits, employer's payroll taxes, and salaries that contain a fixed amount plus commissions.

Total cost = Fixed costs + Variable costs
Total cost = FC + (VC per unit x Number of units)

Example

XYZ Company has entered into several contracts that require it to pay fixed selling costs of $100,000 per month. The cost accountant determined the variable selling cost at $30 per unit. Compute for the total selling cost that would be incurred if the company expects to sell 2,500 units next month.

Solution:
Total cost = Fixed cost + Variable costs
Total cost = $100,000 + ($30 x 2,500)
Total cost = $175,000

Key Takeaways

Total variable costs increase as number of units (cost driver) increase. Variable costs per unit are constant.

Within a relevant range, total fixed costs are constant even if units increase. Fixed cost per unit decreases as units increase.

Mixed costs have elements of both fixed and variable costs. For better analysis of costs, mixed costs are often segregated into variable and fixed.

Web link

APA format

Fixed and variable costs (2022). Accountingverse.
https://www.accountingverse.com/managerial-accounting/cost-behavior/fixed-and-variable-costs.html

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Chapter Outline

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What effect does an increase in the activity level have on average fixed costs per unit variable costs per unit total fixed costs total variable costs?

What effect does an increase in the activity level have on total fixed costs per unit?

How would fixed costs on a per unit basis be affected by an increase in activity level within the relevant range?

What effect does an increase in volume have on a unit fixed costs b unit variable costs c total fixed costs d total variable costs?