Question

"Fixed costs are inversely proportional to volume. As volume decreases, fixed costs increase, and as volume increases, fixed costs decrease." Do you agree with this statement? Explain why, or why not

Answer 1

Fixed cost are inversly proportional to volume. As volume decreases, fixed costs increase and as volume increases, fixed costs decreases.

• The above statement is correct.

Explanation :

• Fixed cost are the cost which incurred at pre-defined/ known amount irrespective of the actual volume of production up to certain level of capacity.
• As cost to be incurred is to be remain fixed in amount; per unit cost decrease as the units of production increases as now that cost can be recovered by more units.
• in the same way per unit fixed cost increase as the units of production decreases as now that cost can be recovered by less units.
• Example of fixed cost includes ; lease, rent, depreciation etc....

lets take an example...

Company A has rented one premises at monthly rate of $ 50,000.

Production capacity is 5000 units.

• i.e. Fixed cost per unit at production capacity is = $50,000 / 5000 units = $ 10 per unit
• Now say actual production is only 2500 units that means burden to recover rent cost is reduced to 2500 units only = 50,000/ 2500 units = 20 Per unit.

• Fixed Cost	Unit	per unit cost
  $ 50,000.00	5000	$    10.00
  $ 50,000.00	2500	$    20.00

• Hence from the above summary and example we can conlcude that per unit cost increase with decrease in volume as cost will incurred irrsepctive of volume. and when volume decrease cost can be recovered from less unit hence per unit cost increases
• and when volume increase per unit fixed cost decrease as fixed cost will incurred irrsepctive of volume. and when volume increase cost can be recovered from more unit hence per unit cost decreases