What type of costs change based on the level of activity or output?

Variable costs are those costs that fluctuate in direct proportion to the level of activity or output in a business. When production increases, variable costs increase, and when production decreases, these costs decline accordingly. This characteristic makes variable costs integral to understanding operational budgets and financial forecasts.

For example, in a manufacturing setting, the costs of raw materials are typically considered variable costs. If a factory produces more units, it will require more raw materials, directly affecting the total variable cost. This relationship allows organizations to adjust their pricing strategies and profit analysis based on expected production levels.

Understanding variable costs is vital for budgeting and cost control, as it enables businesses to predict total costs more accurately and make informed decisions about scaling operations.