Association of Chartered Certified Accountants (ACCA) Certification Practice Test

Why does the average fixed cost curve decrease as production increases?

1. Fixed costs remain constant regardless of production levels

2. Fixed costs are divided among more units produced

3. Variable costs increase with production

4. Average costs are primarily influenced by labor costs

The correct answer is: Fixed costs are divided among more units produced

The decrease in the average fixed cost curve as production increases is attributed to the way fixed costs are spread over units produced. Fixed costs are expenses that do not change with the level of production, such as rent, salaries of permanent staff, or equipment depreciation. When production increases, these fixed costs remain constant in total, but they are distributed across a larger number of units. As a result, the average fixed cost per unit declines because you are allocating the same total fixed costs over more units. For example, if a company's fixed costs are $10,000 and it produces 1,000 units, the average fixed cost per unit is $10. However, if production increases to 2,000 units, the average fixed cost per unit drops to $5. This principle highlights the concept of economies of scale, where increasing production reduces the cost per unit, specifically for fixed costs. The other options do not correctly address the nature of average fixed costs. Fixed costs do not increase or decrease with production levels (which is a characteristic that differentiates them from variable costs). Therefore, understanding the relationship between fixed costs and production volume is crucial in grasping why the average fixed cost curve trends downwards as output rises.