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Chapter 6

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0% found this document useful (0 votes)
7 views12 pages

Chapter 6

Uploaded by

newempir11
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Costs & Scale of Production

Chapter 6
Business Costs
• Costs help managers to calculate profit and loss.

• It also helps managers to make decisions.

• The main 2 types of costs are: fixed costs and variable costs
Business Costs
1) Fixed costs: costs that don’t change with output

• Examples: factory rent, salary of managers

2) Variable costs: costs that change in direct proportion to


output

• Examples: piece-rate labor costs, cost of raw material


Total cost and average cost

Total costs of production = fixed costs + total variable costs

Average cost of production = total costs / total output


Example
Product X
Variable material costs ($ m) 5
Variable labor costs ($ m) 10

Fixed costs ($ m) 9
Number of output 4000

Total variable cost = $5m + $10m = $15m

Total cost = $9m +$15m = $24m

Average cost = $24m / 4000 units =$6000m


Example - 2
Let’s look at a simple example of how total costs can be calculated using
the following example data:

What would Graham’s costs be in March if his forecasts prove correct?


Solution
• Stage 1: calculate variable costs: = £75 x 100 = £7,500

• Stage 2: add together the fixed costs = £2,500 (i.e. £500 +


£1,500 + £100 + £400)

• Stage 3: add variable to fixed costs: total costs are £10,000


(£7,500 + £2,500)
Using Cost data

• Cost data can be used to help make business decisions.

• Setting prices: if the average cost was unknown, business


could charge a price that leads to loss.
Economies of scale
• Are the factors that lead to a reduction in average costs as a business
increases in size.

• Purchasing economies: when large businesses buy large numbers of


components, they are able to gain discounts for buying in bulk.

• Marketing economies: if a business doubles its output and sales, it


wont need to double its marketing costs.
• Financial economies: lenders such as banks often prefer to lend to
large businesses because they consider them less of a risk than
smaller businesses. A lower interest rate is often charged.

• Managerial economies: large businesses can afford specialists and


this increase their efficiency.

• Technical economies: large businesses usually use flow production.


This technology is expensive and only large businesses can afford it.
Diseconomies of scale

• Are the factors that lead to an increase in average costs as a business


grows beyond a certain size.

• Poor communication: large businesses have slow and poor decision


making process which leads to increase in mistakes
• Demotivation of workers: in large businesses, managers may no
longer have day-to-day contact with workers

• Poor control: control and coordination between departments in large


businesses may present many problems

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