What does the term cost behavior mean? It is the relationship between a specific cost and its cost driver, or how a cost changes in response to changes in activity. It is very important to understand how costs behave so that as managers we can predict future cost based on estimated levels of future activity. Generally speaking there are four different patterns of cost behavior. Well, actually there are infinite ways costs can behave, but it's helpful to think of them in four general patterns: variable costs, fixed costs, mixed or semi variable costs and step costs. Variable costs change in proportion to changes in activity. For our purposes, let's use units as our measure of activity. We might also call units a cost driver. What does that cost driver mean? It's something that causes costs to be incurred, here making units causes a cost to be incurred. By contrast, fixed costs do not change with changes in activity. They remain constant regardless of the level of activity. For example, let's go back to the company that makes T-shirts. Again the cost of the fabric to make the T-shirts would be a variable cost, the total cost of the fabric increases as the number of T-shirts made increases and it decreases as the number of T-shirts made decreases. On the other hand, the rent that the T-shirt company pays on its workspace would be a fixed cost because it stays the same regardless of how many T-shirts the company makes. Also, say this T-shirt company employs one full time employee to make the T-shirts, and say the amount paid to the employee would be a fixed cost because the company pays him the same amount in total regardless of the number of T-shirts made. Mixed or semi variable costs have both a variable and a fixed component. Like fixed costs, there are some level of costs that are incurred even when activity is around zero. And like a variable cost, the cost increases as activity increases. And fourth, step costs are fixed within a certain range of activity, but they increase to a new step as activity increases to a new range of activity. For example, suppose the T-shirt company employs one full time sales representative that it pays a base salary plus a commission for each T-shirt sold. Then the compensation for the sales rep would be a mixed cost with the salary being the fixed component and the commission per unit sold being the variable portion. Also, the cost of electricity might be a mixed cost. It is likely that the company incurs some amount of cost for electricity regardless of the number of T-shirts that it makes, because it has the cape lighting on in the workspace. But it's also likely the cost of electricity increases as the company runs its equipment more to make more T-shirts. Now step costs; suppose business was booming and the T-shirt company had to hire an additional full time employee due to the increase in the number of T-shirts it was selling on an ongoing basis. The cost of the labor while still fixed within a certain range, increases to a new level or a new step once the number of T-shirts reaches a certain level.