IGCSE Economics

IGCSE Economics4.2 Costs of Production1Learning OutcomesDefine total and average cost, fixed and variable cost and perform simple calculations

And some which are not on the syllabus but were covering anyway!!

To understand the concept of breakevenTo be able to identify the breakeven output and revenue on a chartTo explain what impact changes in costs and selling price will have on the breakeven output

Some Key TermsTotal CostsFixed CostsVariable CostsAverage CostsWhat do each of these terms mean? Can you explain any differences between them or links between them? Match the key term with the graph

Total CostsFixed CostsVariable CostsAverage CostsMatch the key term with the graphTotal CostsFixed CostsVariable CostsAverage Costs

Match the key term with the graphTotal CostsFixed CostsVariable CostsAverage Costs

A cost which does not change as the level of output changes IN THE SHORT RUN

NOTE: Fixed costs per unit of output (Average Fixed Costs) will decrease as production increases (vice versa)

Fixed CostsWhat might some examples of fixed costs be?

Variable CostsA Variable Cost is a cost which varies directly with outputWe normally consider variable costs in two ways:Variable cost per unitTotal Variable costs (at a given level of output)

What might some examples of variable costs be?

Total CostsAt any level of output:

Total Costs = Fixed Costs + Total Variable CostsWhy does the Total Costs curve look like this?

Average CostsThe Average Cost is the cost per unit of production. It is also known as the unit cost.Average Cost = Total Cost OutputAlso noteAverage Fixed Cost = Fixed Cost Output

Average Cost = VC + AFC

Average Cost Curve for many firms

The average cost of each unit of a good or service will tend to fall as output rises because total fixed costs are spread over a much larger output But, after a point, average costs may start to rise again if it becomes more difficult and expensive to increase outputReminder - RevenueRevenue is the amount of money a firm has coming in from sales of goods and services.

For a particular product it can be calculated by the formula:

Revenue = Selling Price x Quantity Sold (Output)

Calculation time13

Task New Magazine LaunchA publisher wants to launch a new magazine.They plan to sell the magazine for $5.The costs of producing the magazine each magazine will be $2 for materials and $1 for labour.In addition to this the publisher will have to hire a new printing machine for $2,600 and an office space for $1,400

You have to calculate their costs at different levels of output to help them to decide whether they should launch it or not.Fill in this table.Number of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$2,000.00$3,000.00$4,000.00$5,000.00$6,000.00$7,000.00$8,000.00Work column by column from left to rightFixed Costs stay the same at ALL levels of output (in the SHORTRUN)Number of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$4,000$2,000.00$4,000$3,000.00$4,000$4,000.00$4,000$5,000.00$4,000$6,000.00$4,000$7,000.00$4,000$8,000.00$4,000TVC = VC per unit x OutputNumber of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$4,000$3,000$2,000.00$4,000$6,000$3,000.00$4,000$9,000$4,000.00$4,000$12,000$5,000.00$4,000$15,000$6,000.00$4,000$18,000$7,000.00$4,000$21,000$8,000.00$4,000$24,000TC = FC + TVCNumber of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$4,000$3,000$7,000$2,000.00$4,000$6,000$10,000$3,000.00$4,000$9,000$13,000$4,000.00$4,000$12,000$16,000$5,000.00$4,000$15,000$19,000$6,000.00$4,000$18,000$22,000$7,000.00$4,000$21,000$25,000$8,000.00$4,000$24,000$28,000Number of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$4,000$3,000$7,000$7.00$2,000.00$4,000$6,000$10,000$5.00$3,000.00$4,000$9,000$13,000$4.33$4,000.00$4,000$12,000$16,000$4.00$5,000.00$4,000$15,000$19,000$3.80$6,000.00$4,000$18,000$22,000$3.67$7,000.00$4,000$21,000$25,000$3.57$8,000.00$4,000$24,000$28,000$3.50Revenue = Selling Price x OutputNumber of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$4,000$3,000$7,000$7.00$5,000$2,000.00$4,000$6,000$10,000$5.00$10,000$3,000.00$4,000$9,000$13,000$4.33$15,000$4,000.00$4,000$12,000$16,000$4.00$20,000$5,000.00$4,000$15,000$19,000$3.80$25,000$6,000.00$4,000$18,000$22,000$3.67$30,000$7,000.00$4,000$21,000$25,000$3.57$35,000$8,000.00$4,000$24,000$28,000$3.50$40,000Profit/Loss = Revenue - TCNumber of magazines per monthFixed CostsTotal Variable CostsTotal CostsAverage CostTotal RevenueProfit/Loss$1,000.00$4,000$3,000$7,000$7.00$5,000-$2,000$2,000.00$4,000$6,000$10,000$5.00$10,000$0$3,000.00$4,000$9,000$13,000$4.33$15,000$2,000$4,000.00$4,000$12,000$16,000$4.00$20,000$4,000$5,000.00$4,000$15,000$19,000$3.80$25,000$6,000$6,000.00$4,000$18,000$22,000$3.67$30,000$8,000$7,000.00$4,000$21,000$25,000$3.57$35,000$10,000$8,000.00$4,000$24,000$28,000$3.50$40,000$12,000Should the publishing company launch the magazine?QuestionsAt what level of output does the business start to make a profit?Why does the Average Cost keep falling?Will the Average Cost continue to fall as output increases?What is the minimum value for the Average Cost?Should the company launch the magaxine?Clue to the next topic.

Breakeven Analysis

Quick test:Give 2 examples of fixed costs (2)Draw a Fixed Costs, Variable Costs and Total Costs line on a fully labeled axis (5)Give 2 examples of variable costs (2)What is the formula for Revenue? (1)A firm has fixed costs of 2,000 per month. Variable costs of 3 per unit and selling price of 5. In July they sell 1,200 units How much revenue does the firm make? (1)What are the firms Total Costs? (1)What are the firms Total Variable Costs? (1)What are the average costs? (1)How much profit does the firm make in July? (1)

Total marks = 15What Is Breakeven?If a firm is breaking even it means that the business is neither making a profit or a loss.

Breakeven is the output at which a firms total revenue is equal to its total costs.Profit = Total Revenue Total Costs

26QuestionsDo you understand what Revenue and Costs are?What is Revenue?How is is calculated?What are costs?When a business is breaking even the profit figure will be 0, can anyone tell me what Total Revenue and Total Costs need to be to get a profit figure of ?Break Even ChartsCosts/RevenueOutput/SalesInitially a firm will incur fixed costs, these do not depend on output or sales.FCAs output is generated, the firm will incur variable costs these vary directly with the amount produced.VCThe total costs therefore (assuming accurate forecasts!) is the sum of FC+VCTCTotal revenue is determined by the price charged and the quantity sold again this will be determined by expected forecast sales initially.The lower the price, the less steep the total revenue curve.TRBreakeven OutputThe break even point occurs where total revenue equals total costs. The firm will have to produce and sell this number of units to breakevenBreakeven Revenue27Break Even Charts What they showCosts/RevenueOutput/SalesTCTRBreakeven OutputD1LossD2ProfitMargin of safety28Changes in Variable CostsCosts/RevenueOutput/SalesTCTRBEPThe level of variable costs affects the gradient of the Total Costs line.If Variable Costs go up the line will become steeper. What will happen to the Break Even Point?If Variable Costs go down the line will become less steep. What will happen to the Break Even Point?TC1BEP1TC2BEP229Changes in Fixed CostsCosts/RevenueOutput/SalesTCTRBEPThe fixed cost line affects where the Total Cost line starts If fixed costs go up, the Total Costs line will shift upwardsTC1BEP1If fixed costs go down, the Total Costs line will shift downwardsTC2BEP230Changes in Selling PriceCosts/RevenueOutput/SalesTCTRBEPA change in Selling price will affect the gradient of the Total Revenue lineAn increase in the selling price will make the TR line steeperTR1BEP1A decrease in the selling price will make the TR line less steepTR2BEP231QuestionsExplain what will happen to the Breakeven output in the following situations. Illustrate with a diagram.The cost of raw materials increasesThe company moves to premises with cheaper rentThe company decreases the selling price to compete with a new competitorThe electricity supplier increases their prices

Using Contribution to calculate the Breakeven PointQuestionsWork out the Breakeven Output and Breakeven Revenue for the following situations (Remember to show working out)Fixed Cost 3,000; Variable Cost 4.25 Selling Price 8Fixed Cost 89,000; Selling Price 99.99 Variable cost 67.31Fixed Costs 1,000; Selling Price 1.75 Variable cost 93p

Answers3,000/3.75 = 800 units6,400

89,000/32.68 = 2724 units 272,372.76

1000/0.93 = 1220 2,135