Final answer:
An increase in sales volume will potentially affect net profits based on changes in variable and fixed costs. Profits can increase with volume if total costs are constant, or decrease if marginal costs exceed marginal revenue. The exact impact on profit depends on the cost structure and market conditions.
Step-by-step explanation:
An increase in sales volume will create an increase or decrease in net profits depending on what happens with variable and fixed costs. This is because the relationship between revenues, costs, and profits is not linear and can be influenced by several factors:
- If the price of the product remains constant and total costs are held constant, an increase in volume will result in increased profits at every output level.
- When the market price of a product increases, the firm's marginal revenue also increases. The firm will look to increase production to the point where marginal cost equals the new, higher marginal revenue—at the profit-maximizing quantity of output.
- If a firm's marginal costs exceed marginal revenue, it will reduce its profits for every additional unit of output. Therefore, it is most profitable for the firm to adjust its output until marginal revenue equals marginal cost.
- With higher prices, total revenue is increased for every quantity sold; conversely, with lower prices, total revenue decreases. If prices drop to a level where total costs surpass total revenues at every output level, the firm will incur losses but will attempt to minimize these by choosing the output level where total revenues are closest to total costs.
- Variable costs (such as labour and raw materials) will change with an increase or decrease in production volume. As output increases, variable costs typically increase as well.
Therefore, the correct answer to the student's question is option (a) Create an increase or decrease in net profits depending on what happens with variable and fixed costs.