Final answer:
When actual production exceeds planned levels, fixed costs are spread over more units, reducing the average cost per unit. These costs are typically sunk costs and should be ignored in decision-making. Focusing on variable costs is key, as these inform the firm's capacity to manage costs related to changes in production levels.
Step-by-step explanation:
When discussing fixed costs and volume of activity within a business context, we must understand how these costs behave when actual production exceeds planned levels. Fixed costs, such as rent or salaries, do not change with the level of production. Therefore, when a firm's actual volume of activity exceeds the planned volume, the fixed costs are spread over more units of production, lowering the average fixed cost per unit.
It is crucial to note that these fixed costs are often sunk costs—expenses that are already incurred and cannot be recovered. In decision-making, these costs should typically be ignored since they do not alter with changes in production level. Instead, a focus on variable costs is important, as these costs fluctuate with production levels and provide insight into a firm's ability to cut costs and its potential cost increases when ramping up production.
Furthermore, considering the shutdown point is essential when a firm faces losses. This point is where the firm must decide whether to continue operating or shut down. Since fixed costs are already paid in the short run, shutting down only reduces variable costs, and the firm would still incur losses due to these fixed costs. Therefore, a firm may choose to continue producing as long as the total revenue covers the variable costs, even if they cannot cover the total fixed costs in the immediate short run.