Final answer:
Variance analysis is most effective in stable, mature companies that heavily rely on direct labor for predicting budgets and operations. Companies choose production technologies to minimize total costs based on the relative prices of machines and labor; they might shift towards labor-intensive or capital-intensive production methods as these relative costs change.
Step-by-step explanation:
Variance analysis is a tool used by businesses to assess the performance of their operations, particularly in terms of the budgeted and actual costs and quantities of inputs and outputs. It is most effective in stable companies with mature production environments that have predictable costs and operations, and where a significant portion of the work is done through direct labor. These characteristics allow for reliable budgeting and forecasting, making it easier to compare actual results against the standards.
In scenarios where a company faces a change in the cost of inputs, like an increase in the price of machines, one would expect the company to adjust its production technology. For instance, if production technology 1 was initially used with high reliance on machines, but now machines have become more expensive relative to labor, this might prompt a shift to production technology 2, thereby reducing total cost by relying more on labor and less on capital.
However, if machine hours become cheaper, a shift towards production technology 3 would be logical, as this technology leverages on more machines and less labor, once again aligning with the goal of achieving the lowest total cost. This principle reflects the idea that businesses should choose production technologies that optimize their cost structures based on the relative prices of capital and labor, which also aligns with the concept of the long run production function that indicates the most efficient way to produce a given level of output with all factors being variable.