Costs, scale of production and break-even analysis

Fixed costs are costs that do not vary in the short run with the number of items sold or produced. 

Variable costs are costs that vary directly with the number of items sold or produced. 

Total costs are fixed costs and variable costs combined.

Average cost per unit = Total costs/number of units.

Economies of scale

Economies of scale are the factors that lead to a reduction in average costs as a business increases in size. 

1. Purchasing Economies of Scale
2. Marketing Economies of Scale
3. Financial Economies of scale
4. Managerial Economies of Scale
5. Technical Economies of Scale

Diseconomies of scale

Diseconomies of scale are the factors that lead to an increase in average costs as a business grows beyond a certain size. 

1. Poor communication
2. Lack of commitment form employees
3. Weak coordination

Break-even level of output

Break-even level of output is the quantity that must be produced/sold for total revenue to equal total costs. 

Break-even charts are graphs which show how costs and revenues of a business change with sales. They show the level of sales that business must make in order to break even.

The revenue of a business is the income during a period of time from the sale of goods or services. 

The break-even point is the level of sales at which total cost = total revenue

Margin of safety is the amount by which sales exceed the break-even point. 

The contribution of a product is its selling price less its variable cost. 

Uses of break-even charts

Can identify expected profit or loss

Impact on revenue of a certain decision can be analyzed. 

Shows margin of safety

Limitations of break-even charts

• Drawn assuming all units will be sold
• Fixed costs only remain same if the scale of production does not change
• Other aspects should also be considered when making a decision
• Assumed that costs and revenues can be drawn with straight lines.