Costs, Scale of

Production and
Break-even

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Fixed Costs
A cost that does not change as the amount of
products produced or sold changes.

A cost which is incurred even when the

output is 0 and will remain the same in the
short run

Fixed cost per product can be lowered by

making more products.

AVERAGE FIXED COSTS = Fixed Costs / Quantity

Variable Costs
A cost which changes as the amount of goods
produced or sold changes.

Increase in short run output (Q) will cause

Total Variable Costs to rise.

So, in a cookie factory the more cookies that

are produced the higher the costs of
ingredients.

AVERAGE VARIABLE COSTS = Variable Costs / Quantity

Total Costs & Average costs
Total costs are calculated by adding all costs, fixed & variable.

TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

Average costs are calculated for each unit of production.

So, we divide total costs by total output. Average costs are
often used for figuring out the selling price of a
product.
Average cost per product = Total cost / Number of products
produced

If both the AC and level of output is known, then TC can be

calculated by multiplying average cost per unit by output.
TC =Average cost per unit * Output
Using cost data

SETTING PRICES: If the DECIDING WHETHER TO

average cost of one STOP PRODUCTION: If the
unit is $3, then the total cost exceeds the total
price would be set at revenue, a loss is being
least $4 to make a made, and so the
profit of $1 on each production might be
unit. stopped.

DECIDING ON THE
BEST LOCATION:
Locations with the
cheaper costs will be
Chosen.
Identifying and classifying costs is much more likely as a short answer question,

but it forms the building blocks of break-even analysis, and can be a key part of
paper 2 questions where you are asked to make a choice between two product

options.

⭐⭐⭐Top Tip ⭐⭐⭐

It’s really important to learn the definitions and examples for each type of cost, so
you can easily classify costs between fixed and variable, when calculating

break-even point or calculating profits .

Economies of Scale

TING
A RK E S PU
M EO RC
HA
SIN
G EO
S
EOS: Factors that lead
to a reduction in
FINANCIAL average cost as a
EOS business increase in TECHNICAL
size. EOS

MANAGERIAL EOS
 1. PURCHASING ECONOMIES:
• Arise from price reductions due to discounts / bargaining power
• Profit from bulk discounts and a strong bargaining position to
negotiate lower prices (reduce the per-unit costs of the products
they sell significantly).

2. MARKETING ECONOMIES:
• More money for advertising, cutting costs.
• In proportion to sales, large firms can advertise more cheaply
and more effectively than their smaller rivals.
 3. FINANCIAL ECONOMIES:
• Large firms can gain financial savings [they can usually borrow
money (Low Rate of Interest) more cheaply than small firms].
• They usually have more valuable assets that can be used as
security (collateral) - seen to be a lower risk, especially in
comparison to new businesses.
4. Managerial Economies:
• Output increases - specialists can be more fully employed.
• Divide big departments into various sub-departments - each department
placed under the control of an expert.
• A brilliant organizer can devote himself wholly to the work of organizing
while the routine jobs can be left to relatively low paid workers.
5. Technical economies: which accrue to a firm from the use of better
machines and techniques of production (Production increases & cost
per unit of production decreases).
Diseconomies of Scale

POOR
COMMUNICATION

DEOS: As a business
becomes too large, it
SLOW DECISION- becomes less efficient
MAKING leading to higher cost
of production.

LOW MORALE
 POOR COMMUNICATION: It is more difficult to communicate in
larger firms since there are so many people a message must pass
through. The managers might loose contact to customers and make
wrong decisions.

SLOWER DECISION MAKING: More people must agree with a decision &
communication difficulties also make decision making slower as well.

LOW MORALE: People work in large businesses with thousands of workers

do not get much attention. They feel they are not needed this decreases
morale and in turn efficiency.
Break - Even
Break-even level of output is the output at which total revenue equals

total costs (neither a profit nor loss is made, all costs are covered).

In order to draw a break-even chart, the following information is needed:

Fixed costs, Variable costs and Revenue.

Equations:

· Total revenue = price * quantity sold & Total cost = FC + VC

EXAMPLE: CHOCOLATE
BAR
Fixed Costs: $5000/year TC = TFC + TVC = $ 5000 + ( $3 * 2000)
= $11 000
Variable Costs: $3/bar
Selling Price: $8/bar TR = P * Q = $8 * 2000 = $16000
Output: 2000 bars /year
Break – Even Diagram

E.G. https://www.youtube.com/watch?v=6akbg2HTn5I
Alternate way of finding Break - Even

Break Even = Total Fixed Costs / Contribution per unit

Contribution per unit = Selling Price – Variable Costs per unit

= $8 - $3
= $5

Break Even = $5000 / $5

= $1000
Advantages of Break-even charts
Enables managers to see the level of production/sales needed to break
even.

Allows managers to read off expected profit/loss for different levels of sales.

The breakeven chart show the safety margin which is the amount by which
sales exceed the breakeven point.
Margin of Safety (units) = Units being produced and sold – Break-even
output

Managers can change the costs and revenues and redraw the graph to see
how that would affect profit and loss, for example, if the selling price is
increased or variable cost is reduced.
Disadvantages of Break-even charts
The chart is merely a forecast for the future. There is no guarantee that the
figures will prove to be correct.

Assumes all goods manufactured will be sold. This may not always happen!

Break-even charts assume that costs can always be drawn using straight line.
Costs may change due to various reasons (more output produced, workers
may be given an overtime wage that increases the variable cost per unit and
cause the variable cost line to steep upwards).

Fixed costs may not always be fixed if the scale of production changes. If
more output is to be produced, an additional factory or machinery may be
needed that increases fixed costs.
SOURCE:

• Business Studies Textbook by Karen Borrington and Peter Stimpson (5th Edition)

• IGCSE AID notes

• https://www.tutor2u.net/business