Cost Volume Profit
Variable costs are costs that increase as the volume of activity increases but do not increase for the cost per unit.
Understanding cost per unit effects:
Cost per unit does not change - This is because the cost is ordered at the same rate.
Example: Pencil manufacturing.
Consider the cost of producing pencils. The amount of lead used in pencils is $0.25 per pencil.
If plotted on a graph, this would show a linear equation, with the total cost of lead rising my the same amount per additional unit of production.
This is not to be confused with the cost per unit. With variable costs, the costs are fixed per unit and hence do not change. The graph below reflects this. This is because if you produce 1 unit or 5,000 units, the cost of lead per unit of pencil will still be $0.25.
It may not always be realistic for the cost per unit to be fixed at the same price. In many cases, the price per unit may decrease due to additional volume attracting a bulk discount.
The cost per unit for a variable cost attracting a bulk discount would look like a descending staircase as shown below. In this case, the cost of lead per pencil is:
$0.25 for 0-2 units
$0.20 for 3-4 units
$0.15 for 5+ units