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Cost of production Managerial Economics

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Cost of production Managerial Economics

  1. 1. The cost of production is an important factor in almost all business analysis and decision, etc..cost reffers to the expenses incurred in production
  2. 2.  Cost analysis refers to the study of behavior of cost in relation to one or more production criteria like size of output, scale of operation, price of factors of production
  3. 3. Break-Even Analysis There are two basic types of costs a company incurs. • Variable Costs • Fixed Costs Variable costs are costs that change with changes in production levels or sales. Examples include: Costs of materials used in the production of the goods. Fixed costs remain roughly the same regardless of sales/output levels. Examples include: Rent, Insurance and Wages
  4. 4. Break-Even AnAlysis  TOTAL COSTS ◦ Total Costs is simply Fixed Costs and Variable Costs added together. TC = FC + VC ◦ As Total Costs include some of the Variable Costs then Total Costs will also change with any changes in output/sales.
  5. 5. Unit TFC TVC TC 0 60 60-60=0 60 1 60 100-60=40 100 2 60 120-60=60 120 3 60 130-60=70 130 4 60 160-60=110 160 5 60 220-60=160 220 6 60 360-60=300 360
  6. 6. Y TC TVC COST C 0 TFC QUALITY OF OUTPUT X
  7. 7. The Break-even point occurs when Total Costs equals Revenue (Sales Income) Revenues (Sales Income) = Total Costs At this point the business is not making a Profit nor incurring a Loss – it is merely covering its Total Costs Let us have a look at a simple example. Bannerman Trading Company opens a flower shop.
  8. 8. Fixed Costs: • • Rent: £400 Helper (Wages): £200 Variable Costs: • Flowers: £0.50 per bunch Selling Price: • Flowers: £2 per bunch So we know that: Total Fixed Costs = £600 Variable Cost per Unit = £0.50 Selling Price per Unit = £2.00
  9. 9. Break-Even Analysis SP = £2.00 VC = £0.50 FC = £600   We must firstly calculate how much income from each bunch of flowers can go towards covering the Fixed Costs. This is called the Unit Contribution. Selling Price – Variable Costs = Unit Contribution £2.00 - £0.50 = £1.50 For every bunch of flowers sold £1.50 can go towards covering Fixed Costs
  10. 10. Break-Even Analysis Now to calculate how many units must be sold to cover Total Costs (FC + VC) SP = £2.00 VC = £0.50 Unit cont = £1.50 FC = £600 This is called the Break Even Point Break Even Point = Fixed Costs Unit Contribution £600 £1.50 = 400 Units Therefore 400 bunches of flowers must be sold to Break Even – at this the point the business is not making a Profit nor incurring a Loss – it is merely covering its Total Costs
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