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IAI Actuarial Core Principles · Business Economics · Production, costs, revenue and profit in price and output decisions

A small Pune bakery pays a fixed monthly rent of ₹30,000 regardless of how many loaves it bakes. As monthly output rises from 1,000 to 3,000 loaves, which statement about the rent is correct?

Average fixed cost falls as output rises, because total fixed cost stays constant at ₹30,000 and is divided across more loaves. It falls from ₹30 to ₹10 per loaf. Total fixed cost and marginal cost are not changed by output.

  1. ATotal fixed cost rises, because more loaves need more space
  2. BAverage fixed cost falls, because the same total is spread over more unitsCorrect
  3. CMarginal cost falls, because rent is spread over more loaves
  4. DAverage variable cost rises, because rent is a variable cost
  5. Total fixed cost falls, because output is higher

Explanation

Rent is a fixed cost, so the total stays at ₹30,000. Average fixed cost is total fixed cost divided by output, so it falls from ₹30 to ₹10 per loaf. Fixed costs do not affect marginal cost, so the option on marginal cost is wrong.

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