Final answer:
Variable costs, such as labor and raw materials, fluctuate according to production volume. Average variable cost is determined by dividing variable costs by total output, and it affects a firm's potential profitability when compared to market prices.
Step-by-step explanation:
True: Variable costs do indeed vary with the level of production or sales volume. We treat costs like labor and raw materials as variable costs, because producing more goods or services generally requires additional workers, work hours, or materials. As such, variable costs increase or decrease with changes in output.
Calculating the average variable cost involves dividing the variable cost by the total output at each level of output. These costs are known to have a typical U-shape in their behavior. Importantly, if the average variable cost of production is less than the market price, a firm has the potential to earn profits, assuming fixed costs are not considered.