4.2 Costs, scale of production and break-even analysis

Question 1

Fixed costs

Answer 1

Costs that do not change with output

Question 2

Variable costs

Answer 2

Costs that change in direct proportion to output

Question 3

Total cost

Answer 3

All the variable and fixed costs of producing the total output
= variable costs + fixed costs

Question 4

What are the uses of cost data?

Answer 4

Setting prices
Deciding whether to stop production
Deciding on the best location

Question 5

Economies of scale

Answer 5

Factors that lead to a reduction in average costs as a business increases in size

Question 6

Financial

Answer 6

Lenders such as banks often prefer to lend to large businesses because they consider them less of a risk than smaller businesses

Question 7

Managerial

Answer 7

As a business grows, it often employs specialist managers for the different functional area, which improves the quality of business decisions and make fewer mistakes

Question 8

Marketing

Answer 8

Average costs of marketing falls as output and sales increase

Question 9

Purchasing

Answer 9

Large businesses usually buy greater quantities of raw materials. Suppliers often offer discounts on large or bulk purchases

Question 10

Technical

Answer 10

Technology enables businesses to produce very high levels of output at lower unit costs

Question 11

Diseconomies of scale

Answer 11

Factors that cause average costs to rise as the scale of operations increases

Question 12

Factors of diseconomies of scale

Answer 12

Poor communication
Demotivation of workers
Poor Control
Alienation of staff
Slow decision making

Question 13

Break-even

Answer 13

level of output where revenue equals total costs; business is making neither profit nor loss.

Question 14

Breakeven analysis

Answer 14

shows the relationship between revenue, costs and volume of output/sales.

Question 15

Use of breakeven analysis

Answer 15

Calculate how many units it needs to sell before it starts to make a profit
Calculate effect on profit of increasing or decreasing the price of a product
Calculate effect on profits of an increase or decrease in business costs

Question 16

How to calculate breakeven sales?

Answer 16

Total fixed costs / Contribution Selling price - variable cost per unit

Question 17

Limitations of breakeven chart

Answer 17

It assumes that all costs and revenues can be represented by straight lines
It is not easy to separate costs into fixed and variable
It assumes that all output is sold - it does not allow for inventories and the costs of holding these

Question 18

Ways in which break even analysis may be helpful:

Answer 18

Planning/forecasting/decision making/helping set prices
Help work out level of profit at different levels of output
Show margin of safety
Shows how much needed to produce to avoid loss
Help apply for finance