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

• Fixed Costs: costs that do not vary with output produced or sold in the short run. 
• Variable Costs: costs that directly vary with the output produced or sold.
• TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS
• AVERAGE COST = TOTAL COST/ TOTAL OUTPUT
• Economies of scale: the factors that lead to a reduction in average costs as a business increases in size.
• Diseconomies of scale: the factors that lead to an increase the average costs of a business as it grows beyond a certain size. 
• Break-even level output: the quantity that must be sold produced for total revenue to equal total costs (also known as break-even point)
• Revenue: the income during a period of time from the sale of goods or services
• Total revenue = quantity sold x price
• Break-even point: the level of sales at which total costs = total revenue.
• Margin of safety: the amount by which sales exceed the break-even point.
• Contribution: the contribution of a product is its selling price less its variable costs.
• Economies of scale.

  • purchasing
  • marketing
  • financial
  • managerial
  • technical
• Diseconomies of scale:

  • poor communication
  • low morale leading to low efficiency
  • slow decision-making and weak coordination
• Fixed costs do not vary with output in short run and include:

  • rent
  • interest on loans
  • insurance
  • management salaries
• Variable costs change directly with output:

  • raw materials
  • electricity used in production
  • some labour costs, e.g. piece rate pay and wages of temporary workers
• Advantages of break-even charts:

  • find out the profit or loss 
  • calculate the safety margin
  • managers can change the costs and revenues and redraw the graph to see how that would affect profit and loss
• Limitations of break-even charts:

  • costs and prices might change frequently - new graph required
  • assumes all products are sold
  • costs and revenue might not be 'straight lines'
• Break-even level of production = Total fixed costs / Contribution per unit
• Contribution = Selling price – Variable cost per unit