Chapter 18 – Costs, scale of production and break-even
analysis
Costs and Scale of Production
Need to Measure Costs: To compare with revenue, calculate
profit/loss, set prices, and make informed decisions.
Accurate cost info crucial for future planning and decision making.
Business Costs
Fixed Costs (FC): Do not change with output in the short run. Also
called overheads or indirect costs. Examples: rent, insurance, bank
fees.
Variable Costs (VC): Vary directly with output. Also known as direct
costs. Examples: raw materials, electricity, shipping.
Total Cost: Sum of fixed and variable costs.
Average Cost (Per Unit): Total cost divided by total output. Referred
to as unit cost.
Economies of Scale (EOS)
As scale of production rises, Long Run Average Costs (LRAC) fall.
Factors leading to reduction in average costs as business size
increases.
Types of economies of scale: purchasing, marketing/selling, financial,
managerial, technical.
Diseconomies of Scale (DEOS)
As scale of production rises, LRAC rise.
Factors leading to increase in average costs beyond a certain size.
Types of diseconomies of scale: poor communication, low morale, slow
decision making.
Break-Even Charts
Show how costs and revenues change with sales.
Breakeven level indicates minimum goods for profit.
Breakeven point (BEP): Total Cost = Sales Revenue.
BEP = Total fixed cost / Contribution per unit.
Contribution per unit = Selling price per unit - variable cost per unit.
Benefits of Break-Even Charts
Predict profit/loss at any output level.
Test scenarios and their impact on profit/loss.
Show safety margin (sales exceeding break-even point).
Limitations of Break-Even Charts
Assumes all products sold.
Fixed costs change with scale.
Assumes straight-line costs and revenues.
Flashcards:
Front Back
Need to Measure - Compare with revenue, calculate profit/loss, set prices - Accurate cost
Costs info for future planning and decisions
- Fixed Costs (FC): Overheads, do not change with output - Variable
Costs (VC): Direct costs, vary with output - Total Cost, Average Cost (Per
Business Costs Unit)
- LRAC fall with increased scale - Factors reducing average costs as
Economies of Scale business size increases - Types of economies of scale: purchasing,
(EOS) marketing, financial, managerial, technical
- LRAC rise with increased scale - Factors increasing average costs
Diseconomies of beyond a certain size - Types of diseconomies of scale: poor
Scale (DEOS) communication, low morale, slow decision making
- Show costs and revenue changes with sales - Breakeven level, point,
Break-Even Charts calculation - Contribution per unit, safety margin
Benefits of Break- - Predict profit/loss, test scenarios, safety margin - Managers use for
Even Charts decisions
Limitations of - Assumes all products sold - Fixed costs change with scale - Assumes
Break-Even Charts straight-line costs and revenues
Lesson Plan Learning Objectives
Lesson: Costs and Objective: Understand the concept of costs in business and how the
Scale of Production scale of production affects costs and efficiency.
Lesson Content:
Lesson Plan Learning Objectives
- Explain the importance of measuring costs in business for
Need to Measure comparison, profit calculation, price determination, and decision
Costs making.
- Differentiate between Fixed Costs (FC) and Variable Costs (VC) and
Business Costs provide examples of each.
- Define Total Cost and Average Cost (Per Unit) and their significance
in cost analysis.
Economies of Scale - Describe Economies of Scale (EOS) and how they lead to a
(EOS) reduction in average costs as production scale increases.
- Enumerate the types of economies of scale: purchasing,
marketing/selling, financial, managerial, and technical.
- Outline Diseconomies of Scale (DEOS) and how they cause an
Diseconomies of Scale increase in average costs as production scale surpasses a certain
(DEOS) size.
- List types of diseconomies of scale, including poor communication,
low morale, and slow decision making.
Lesson Plan Learning Objectives
- Introduce Break-Even Charts and their purpose in illustrating the
Break-Even Charts relationship between costs, revenues, and sales.
- Define the Break-Even Point (BEP) and its calculation using Total
Fixed Cost and Contribution per unit.
Benefits of Break-Even - Explain the benefits of using Break-Even Charts, such as predicting
Charts profit/loss, testing scenarios, and understanding the safety margin.
- Discuss the limitations of Break-Even Charts, including assumptions
Limitations of Break- about product sales, fixed cost behavior, and straight-line costs and
Even Charts revenues.