Question

Explain the relationship between the number of units sold in a day in a fast food restaurant and each of the following: total fixed costs per unit of activity, total variable costs, variable cost per unit of activity, total costs, and average total cost per unit of activity.

Answer 1

The relationship between number of units sold in a day and the listed items are explained below:

1) total fixed costs per unit of activity:

The total fixed costs per unit of activity bears an inverse [but not linear] relationship to the units of activity. As the total fixed costs remain the same [within the relevant range of activity], the total fixed cost per unit increases when the units of activity decreases and vice versa.

2) total variable costs:

The total variable costs vary directly with the units of activity. This is because, the unit variable cost remains the same within the relevant range of activity. Thus, when units of activity decrease the total variable cost decreases proportionately and vice versa.

3) variable cost per unit of activity:

The variable cost per unit of activity remains the same irrespective of the level of activity [within the relevant range]. So, whatever the number of units of activity, the variable cost per unit remains the same.

4) total costs:

The total cost is the sum of total variable cost and total fixed cost.

As total cost remains the same irrespective of the units of activity and total variable cost varies directly with the units of activity, the total cost increases as the units of activity increase and vice versa.

5) average total cost per unit of activity.

The average total cost per unit of activity varies inversely with the units of activity though not linearly. As the units of activity increase, the average total cost per unit decreases and vice versa.