4.2 - costs, scale of production and breakeven analysis

Question 1

what are fixed costs (overheads)?

Answer 1

costs that do not change with the number of items sold or produced. They have to be paid regardless if the business sells the products or not e.g., Rent, management salaries.

Question 2

what are variable costs?

Answer 2

Variable Costs: These are costs that do change with the number of items sold or produced. E.g., raw material costs, piece rate labour. ​

Question 3

what are total costs?

Answer 3

Total Costs= Total Variable costs + Total Fixed Costs ​

Question 4

what are average (unit) costs?

Answer 4

​Average Cost (Unit Cost)= Total Costs of production /Total Output ​

Question 5

what is total revenue?

Answer 5

Total Revenue= Price x Quantity sold ​

Question 6

what is profit?

Answer 6

Profit= Total Revenue – Total Costs

Question 7

what is the concept of breakeven?

Answer 7

The breakeven level of output is the quantity of goods that must be produced/sold for total revenue to equal total costs. ​at this point the business have covered all of their costs

Question 8

what is the calculation of breakeven?

Answer 8

Fixed costs/contribution per unit

Question 9

how do you calculate contribution per unit?

Answer 9

selling price- variable cost per unit

Question 10

what is the margin of safety?

Answer 10

the amount by which current sales exceed the breakeven point. it is calculated by (current sales - breakeven point)

Question 11

draw a breakeven graph

Answer 11

check teams

Question 12

what are the benefits of breakeven analysis?

Answer 12

• managers can read off the graph how much profit/loss the business has made at any level of output​
• allows the business to see the impact on the Breakeven Point if the business decides to increase the Selling price /decrease Variable Costs ​- allows the business to see the Margin of Safety, to determine if they are at high/low risk of making a loss ​

Question 13

drawbacks of breakeven analysis

Answer 13

• breakeven calculations may be inaccurate if the selling price changes over time. E.g. at times the business might have to reduce their selling price to attract customers causing the calculation/BEP to be inaccurate. ​
• assumes the fixed costs never change with output. However, eventually they will increase if the business has to move to a bigger factory as rent costs will increase ​

Question 14

what are economies of scale? (definition)

Answer 14

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

Question 15

what are the 5 economies of scale and how do they work?

Answer 15

Purchasing - when a business grows they need more stock. by buying in bulk they can negotiate discounts from suppliers, reducing average costs.

Marketing - a businesses’ ad costs will be spread over more units as the business increase in size and sells more units, lowering average costs.

Financial - banks consider larger firms as less risky than smaller ones so lower interest rate in charged on bank loans, reducing fixed costs and average costs.

Technical - larger firms can afford specialist machinery and so are more efficient and therefore average costs are lowered.

Managerial - large firms can afford specialist managers who tend to be more efficient, reducing average costs.

Question 16

what are diseconomies of scale?

Answer 16

the factors that lead to an increase in average costs as a business grows beyond a certain size.

Question 17

what are the 3 diseconomies of scale and how do they work?

Answer 17

Poor Communication - the larger the business, the harder to communicate between staff. this may lead to mistakes causing inefficiencies and therefore higher average costs

Lack of Commitment from Employees - in a large firm, employees may feel alienated and not valued, leading to demotivation and therefore inefficiency.

Weak Coordination - difficult to coordinate a large business as there’s so many employees. this may lead to lack of coordination between employees, causing inefficiencies and higher average costs