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CA Foundation · Business Economics · Theory of Production and Cost

In the short run, a factory has fixed assets (machines, building) that cannot be changed, but can adjust the quantity of raw materials and workers hired. Which of the following correctly describes the nature of costs in this scenario?

Rent is a fixed cost because it must be paid regardless of output level in the short run. Raw material cost is a variable cost because it increases as production increases. This distinction is fundamental to short-run cost analysis.

  1. ABoth rent and raw material costs are fixed costs
  2. BRent is a fixed cost; raw material cost is a variable costCorrect
  3. CBoth rent and raw material costs are variable costs
  4. DRaw material cost is fixed; rent is variable

Explanation

In the short run, fixed costs are those that do not change with output level—rent, depreciation, and insurance on fixed assets remain constant. Variable costs change directly with output—raw materials, wages for additional workers, and power consumed vary as production volume changes. The factory must pay rent whether it produces 100 or 1000 units, but it must buy more raw materials to produce more units.

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