Final answer:
Variable costs are relevant when comparing decision alternatives with different activity levels or costs per unit of activity
. They are directly affected by the production output and typically show diminishing marginal returns.
Step-by-step explanation:
Variable costs are relevant when decision alternatives have different activity levels or different costs per unit of activity.
Therefore, the correct answer to the student's question is that variable costs respond to changes in the level of activity, and they are relevant when decision alternatives have different activity levels or different cost per unit of activity (option b).
Fixed costs, on the other hand, are considered sunk costs and do not change with the level of production, so they tend to be irrelevant for decisions about future production or pricing.
It is important to note that variable costs are associated with diminishing marginal returns, which implies that the marginal cost of producing higher levels of output generally rises. This concept is crucial for business owners and managers when they are making economic decisions, as it affects both production planning and pricing strategies.