Download Costs 5.2

Costs and Revenue
IB Syllabus 5.2
Text unit 5.2
Costs
 Any money expenditures incurred
 During the production of the good or service
 Or in getting the output into the hands of the
customer
Understanding and managing costs
 Classification of costs
 into fixed and variable, direct and indirect
 Variance analysis
 to see if the business is keeping control of its costs
 Break even analysis (unit 5.3)
 tells a business how much it needs to sell to cover its costs
 Marginal cost
 Opportunity cost
 the financial benefit forgone of the next best alternative
use of money.
Costs:
Fixed, variable, semi, direct, indirect
 Fixed costs
 Do not change as output does
 Variable costs
 Do change with output changes
 Semi variable costs
 Included elements of both fixed and variable
 Car salesman is paid a salary but also receives a
commission if he/she sells a car
 Direct costs
 Directly attributable to the production or procurement
of the output (COGS)
 For breakeven analysis, direct costs are variable.
 Indirect costs
 Called overheads
Coca Cola and Costs
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Videos\the firm 1 soft drinks.mpg
Total Costs
 Total cost is the sum of all costs:
 fixed costs plus variable costs
 The total cost curve is up-sloping curve
 costs increase as output volume increases.
 The total costs of Con’s Kitchen increase as the number of
meals served increases
 When Con’s Kitchen becomes overcrowded and the law of
diminishing returns sets in
 the total costs increase quickly
 employees become less efficient as the kitchen gets busier
Total Cost Curve for Con’s Kitchen
$1,000
Total dollars
Total
cost
Variable
cost
500
Fixed
cost
Fixed
cost
200
0
3
6
9
12
15
Tons per day
Average Fixed Cost
total fixed cost by the quantity produced
 AFC=TFC/Q
Average fixed cost curve is represented
graphically as an ever decreasing curve
asymptotic to the horizontal axis.
For example:
 rent paid by Con’s Kitchen is divided (or allocated),
among more and more meals as the volume of
production increases.
 average cost per meals attributable to the fixed rent
decreases as the number of meals increases.
Average Variable Cost
 calculated by dividing total variable cost by
quantity produced
 AVC = TVC / Q
 The average variable cost curve is graphically
represented by a U shaped curve reflecting the
increasing efficiency followed by decreasing efficiency in
production as volume changes.
 Starting from a few meals and customers, Con’s Kitchen
can improve its efficiency and decrease its average
variable cost per meal as it increases its volume
(product).
 But, if we expand too much, the average variable cost
starts to rise as more employees start to get in each
other’s way
Average Total Cost
 calculated by dividing total cost by the
quantity produced
 ATC=TC/Q.
 The average total cost curve is represented
graphically as a U shaped curve with a steep
decreasing portion and a mildly increasing
portion.
These are attributable to the fixed and variable
cost patterns.
 The pattern of the average total cost at Con’s Kitchen
is a combination of the pattern of average fixed costs
and average variable costs.
 As output increases, average total cost decreases
then increases with diminishing returns.
Marginal Cost
 calculated by dividing the change in total
cost by the change in quantity.
 MC=(change in TC)/(change in Q).
 represented graphically by a U shaped curve
reflecting the increasing then decreasing
efficiency as volume increases.
 The marginal, or additional, cost per meal at Con’s
Kitchen changes more than the average total cost for
each meal.
 the cost of one additional meal start to increase before
average total cost does.
Marginal Cost Curve on Graph
The shape of the marginal cost curve
can be explained by the pattern of
total cost:
 it is due to the law of diminishing returns.
The trough (or minimum) of the
marginal cost curve corresponds to
the point of diminishing returns.
Cost per ton
Marginal Cost Curve for Con’s Kitchen
$100
50
Marginal
cost
25
0
3
6
9
12
Tons per day
Average and Marginal Cost Curves
for Con’s Kitchen
$150
Cost per ton
125
Marginal cost
100
75
Average total cost
50
Average variable cost
25
Average fixed cost
0
5
10
15
Tons per day
Variance Analysis
 Standard costs (aka budgeted costs)
 The expected or projected level of costs
associated with the production of a
good/service
Actual costs – Standard costs = Variance
 Monitoring variances can help the
business to identify where inefficiencies
or efficiencies might lie
Marginal Cost
 The cost of producing one extra unit
of output
 Marginal cost is a variable cost
 Selling price – MC = Contribution
 Contribution is the amount which can
contribute to the fixed overheads
(costs)
 Any revenue received which exceeds
direct and variable costs then contributes
to the fixed costs
Opportunity Cost
 Value of the next best alternative not
chosen
 Value of the thing given up when you choose
between two things
 A business can measure the outcome of a
decision by comparing it with the benefits
(probably measured in profits or revenue) it
could have had if it had taken the next best
option.
 The opportunity cost of buying a new piece of
machinery might be compared with the benefits of
spending the money on a new advertising campaign.
Total Revenue
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Total Revenue = Price x Quantity Sold
Price can be raised or lowered to change revenue
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price elasticity of demand important here
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If
If
If
If
it
it
it
it
is
is
is
is
elastic and we raise price, revenue drops
elastic and we lower price, revenue increases
inelastic and we raise price, revenue increases
inelastic and we lower price, revenue drops
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penetration, psychological, etc.
Different pricing strategies can be used
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Quantity sold is a function of price and demand
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We can sell more at the same price, thereby increasing
revenue
Is influenced by amending the elements of the marketing mix
Demand
Is the market
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The 7 Ps
Marginal Revenue
 Marginal Revenue.ppt