Basis: How the cost behaves as activity level changes
The Inverse Behaviour Pattern
| Cost Type | Total | Per Unit |
|---|---|---|
| Variable | Changes with activity | Constant |
| Fixed | Constant | Changes with activity (inversely) |
Variable Costs
Definition: Cost that varies in total direct proportional to activity level.
| Example | Activity Measure | Behavior |
|---|---|---|
| Direct materials (batteries) | Units produced | 1 battery per bus, always |
| Electricity ($2/machine-hour) | Machine hours | More production = more power |
| Sales commission ($30/table) | Units sold | Zero sales = zero commission |
Formula:
| Units | Cost/Unit | Total Variable Cost |
|---|---|---|
| 1 | $50 | $50 |
| 500 | $50 | $25,000 |
| 1,000 | $50 | $50,000 |
Fixed Costs
Definition: Cost whose total remains constant regardless of activity level.
| Example | Behavior |
|---|---|
| Rent | Same monthly payment whether you make 10 or 10,000 units |
| Supervisor salary | Same whether factory runs at 50% or 100% capacity |
| Insurance | Premium doesn’t change with production volume |
The Per-Unit Trap
Fixed costs per unit decrease as volume increases—but total hasn’t changed. Don’t confuse lower average cost with actual savings.
| Fixed Cost | Units | Average Cost/Unit |
|---|---|---|
| $8,000 | 10 | $800 |
| $8,000 | 500 | $16 |
| $8,000 | 2,000 | $4 |
This is arithmetic, not real cost reduction.
Connection to Economics
| Timeframe | Accounting Term | Economics Term |
|---|---|---|
| Short-run | Lower average fixed cost per unit | Movement along SRAC curve |
| Long-run | Step change in fixed costs (new capacity) | Moving to different SRAC curve |
| Very long-run | Technology shifts cost structure | LRAC curve shifts downward |
Relevant Range = one short-run average cost curve. Exceed it → step change.
North: Where this comes from
- Cost Classification Framework (one of three axes)
- Short-Run Cost Curves (microeconomics foundation)
East: What opposes this?
- Mixed Costs (combination of both)
- Step Costs (fixed within range, then jumps)
South: Where this leads
- Cost-Volume-Profit Analysis (uses this distinction for planning)
- Break-Even Analysis (depends on separating fixed from variable)
- Contribution Margin (revenue minus variable costs)
West: What’s similar?
- Economies of Scale (spreading fixed costs = lower average cost)
- Operating Leverage (high fixed costs = more volatile profits)