In terms of costs, what is the main difference between fixed and variable costs?

• A. Fixed costs are always higher than variable costs
• B. Variable costs fluctuate with output, while fixed costs do not
• C. Fixed costs are only applicable to non-profit organizations
• D. Variable costs include only materials

Answer: (B)

The main difference between fixed and variable costs lies in their behavior in relation to the level of production or business activity. Fixed costs are expenses that do not change with the level of output. They remain constant regardless of how much a business produces, such as rent, salaries, and insurance. On the other hand, variable costs fluctuate directly with the level of production. As output increases, variable costs increase proportionally, as they include costs like raw materials, labor directly involved in production, and utilities that may depend on usage.

This understanding is crucial for businesses to manage their budgets effectively, as it helps in forecasting costs and determining break-even points. While fixed costs provide stability in financial planning, variable costs represent the scalable part of a business's cost structure, allowing more flexibility as production demands change. This dual nature of costs plays a vital role in pricing strategies and overall financial health.