Costs, scale of production and break-even analysis

• Fixed costs are costs that do not vary with the number of items sold or produced in the short run. They have to be paid whether the business is making any sales or not.
• Variable costs vary directly with the number of items sold or produced.
• How do businesses use cost data?

  Set prices- the average cost per unit is not known, the business could charge a price that could lead to a loss being made on each item sold.

  Deciding on the best location- costs are not the only factor to consider, there is no point in buying a low-cost location if its in the worst part of town.
• Economies of scale are the factors that lead to a reduction in average costs as the business increases in size.
• What are the economies of scale?


  Purchasing economies- when businesses buy large numbers of components, they will be able to get a discount for buying in bulk.

  Marketing economies- the business will be able to depend on itself instead of staff.

  Financial economies- large businesses are able to raise capital more cheaply than smaller ones because banks are more willing to lend to large organizations.

  Managerial economies- large companies can afford specialists and this increases their efficiency and helps to reduce their average costs.
• What are the diseconomies of scale?

  Poor communication- as businesses get larger it becomes more difficult to send and receive accurate messages.

  Low morale- some workers will never get to see the top managers of the business and they feel that they are unimportant and not valued by the management. This can lead to low morale and low efficiency amongst workers.

  Slow decision-making- It takes longer for decisions made by managers to reach all groups of workers.
• Break-even level of output is the quantity that must be sold or produced for total revenue to equal total cost.
• Advantages of break-even charts

  It shows the profitability of the business.

  It shows the safety margin- the amount by which sales exceed the break-even point.
• Break-even point:$Total fixed costs/contribution margin$