4.2 Costs, scale of production and break-even analysis Flashcards
What are fixed costs?
Costs that do not change with output (e.g. rent, salaries, insurance)
What are variable costs?
Costs that change directly with output (e.g. raw materials, electricity, shipping)
What is the formula for total cost?
Fixed cost + Variable cost
What is the formula for average cost?
Total cost ÷ Total output
What is average cost also called?
Unit cost
What is the formula for fixed cost?
Total cost – Variable cost
What is the formula for variable cost?
Total cost – Fixed cost
Why do businesses use cost data?
To set prices, decide to stop/continue production, choose location, and calculate profit/loss
What are economies of scale?
Cost savings when a business grows and increases output
What are purchasing economies of scale?
Buying in bulk reduces cost per unit
What are marketing economies of scale?
Advertising cost spreads over more units, reducing unit cost
What are financial economies of scale?
Big businesses get lower interest rates on loans
What are managerial economies of scale?
Large firms hire specialists to improve efficiency
What are technical economies of scale?
Investing in better machinery reduces average costs
What are diseconomies of scale?
Higher average costs when a business becomes too large
What causes poor communication in big businesses?
Too many departments and employees
Why do large firms face low commitment from workers?
Workers feel disconnected from top management
What causes weak coordination in large firms?
Long chains of command and slow decision-making
What is break-even?
When total revenue = total cost
What is the break-even formula?
Fixed costs ÷ Contribution per unit
What is contribution per unit?
Selling price – Variable cost
What is total revenue?
Quantity sold × Price
What is the margin of safety?
Actual sales – Break-even sales
What does a break-even chart show?
Costs, revenue, and the break-even point
What is shown on the x-axis of a break-even chart?
Number of units sold or produced
What is shown on the y-axis of a break-even chart?
Costs and revenue (money)
What is the area before the break-even point?
Loss area
What is the area after the break-even point?
Profit area
What is a benefit of break-even charts?
Shows profit/loss at different outputs, helps decision-making
What is another benefit of break-even charts?
Allows managers to test different scenarios
What is the margin of safety on the chart?
Output beyond the break-even point
What is a limitation of break-even analysis?
Assumes all products made are sold
What is another limitation of break-even charts?
Fixed costs may change if production scale changes
Why are break-even lines not always accurate?
Costs and revenue may not increase in straight lines
