4.2 – Costs, Scale of Production and Break-even Analysis

Question 1

What are Fixed Costs?

Answer 1

Costs that do not vary with output produced or sold in the short run. eg: rent.

Question 2

What are Variable Costs?

Answer 2

costs that directly vary with the output produced or sold.

Question 3

What are the Total cost formulas?

Answer 3

TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

TOTAL COST = AVERAGE COST * OUTPUT

Question 4

What is average cost formula?

Answer 4

AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT

Question 5

What are economies of scale?

Answer 5

The factors that lead to a reduction in average costs as a business increases in size.

Question 6

What are the five economies of scale?

Answer 6

Purchasing economies
Marketing economies
Financial economies
Managerial economies
Technical economies

Question 7

What are Purchasing Economies?

Answer 7

Bulk-buying discounts that reduce costs

Question 8

What are Marketing Economies?

Answer 8

Larger businesses will be able to afford it’s own vehicles to distribute goods and advertise on paper and TV. They can cut down on marketing labour costs.

Question 9

What are Financial Economies?

Answer 9

Bank managers will be more willing to lend money to large businesses. Thus they will be charged a low rate of interest on their borrowings

Question 10

What are Managerial Economies?

Answer 10

Can afford to hire specialist managers

Question 11

What are Technical Economies?

Answer 11

Can afford to buy large machinery

Question 12

What are Diseconomies of scale?

Answer 12

Factors that lead to an increase the average costs of a business as it grows beyond a certain size.

Question 13

What are the Diseconomies?

Answer 13

Poor communication
Low morale
Slow decision-making

Question 14

How does poor communication affect average cost?

Answer 14

Messages may be inaccurate and slow to receive, leading to lower efficiency and higher average costs in the business.

Question 15

How does low morale affect average cost?

Answer 15

workers may feel unimportant and not valued by management. This would lead to inefficiency and higher average costs.

Question 16

How does slow decision-making affect average cost?

Answer 16

Communication will get very slow and so any decision-making will also take time

Question 17

What is Break-Even Output?

Answer 17

Output level at which total revenue equals total cost

Question 18

What does a break-even chart show?

Answer 18

the costs and revenues of a business across different levels of output and the output needed to break even.

Question 19

What are the advantages of break even chart?

Answer 19

Managers can see profit or loss at each level of output
Can change costs and revenue to see how profit or loss is affected
Can help calculate safety margin - amount by which sales exceed break even point

Question 20

What are the limitation of break even charts?

Answer 20

Constructed assuming all units produced are sold
Fixed costs may not always be fixed
Assumes costs can be drawn in straight line

Question 21

What is the break-even formula?

Answer 21

Total fixed costs/ contribution per unit

Question 22

What is the Contribution formula?

Answer 22

Contribution = Selling price – variable cost per unit