Costs, scale of production and break-even analysis.
How costs are classified.
- The main classifications of cost are:
Fixed costs
Variable costs
Total costs
Average costs
Fixed cost- Are costs that do not change with output. Eg factor rent and salary of managers.
Variable costs- Costs that change in direct proportion to output. Eg cost of raw materials.
Total costs- All the variable and fixed costs of producing the total output. Eg fixed cost of producing 200
units of output is $3000 and the total variable cost of producing 200 units is $5000, then the total cost of
producing 200 units is $8000 ($3000 + $5000).
Average cost- The cost of producing a single unit of output. Average cost = Total cost/Output. Eg
($8000/200= $40).
Using cost data to make simple cost based decisions.
Use of cost data Example Explanation
Setting prices Average cost of making a pizza = If the average cost per unit is
$3 not known the business could
If the business wants to make charge a price that leads to a
$1 profit on each pizza sold, it loss being made on each item
will charge a price of $4. sold’
Deciding whether to stop If the total annual cost of No business wants to continue
production or continue producing a product is $25000 to make a loss but the decision
but the total revenue is only depends on whether fixed costs
$23000,then the business is will still have to be paid. Eg if
making a loss and could decide the factory being used for the
to stop making the product. production is not sold.
Deciding on the best location Location A for a new shop has a Costs are not the only factor to
total annual cost of $34000 and consider, they might not be any
location B for a new shop has a point in choosing a low cost
total cost of $50000, therefore location for a new shop if it is
using this cost data alone the worst part of town.
location A should be chosen
