1. IGCSE Economics
4.2 Costs of Production

2. Learning Outcomes
Define total and average cost, fixed and variable cost and perform simple calculations
And some which are not on the syllabus but we’re covering anyway!!
To understand the concept of breakeven
To be able to identify the breakeven output and revenue on a chart
To explain what impact changes in costs and selling price will have on the breakeven output

3. Some Key Terms Total Costs Fixed Costs Average Costs Variable Costs
What do each of these terms mean? Can you explain any differences between them or links between them?

4. Match the key term with the graph
Fixed Costs
Variable Costs
Total Costs
Average Costs

5. Match the key term with the graph
Fixed Costs
Variable Costs
Total Costs
Average Costs

6. Match the key term with the graph
Fixed Costs
Variable Costs
Total Costs
Average Costs

7. Fixed Costs What might some examples of fixed costs be?
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)
What might some examples of fixed costs be?

8. Variable Costs
A Variable Cost is a cost which varies directly with output
We normally consider variable costs in two ways:
Variable cost per unit
Total Variable costs (at a given level of output)
What might some examples of variable costs be?

9. Total Costs
At any level of output: Total Costs = Fixed Costs + Total Variable Costs
Why does the Total Costs curve look like this?

10. Average Costs
The Average Cost is the cost per unit of production. It is also known as the unit cost.
Average Cost = Total Cost
Output
Also note……
Average Fixed Cost = Fixed Cost
Average Cost = VC + AFC

11. 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 output

12. Reminder - Revenue
Revenue 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)

13. Calculation time

14. Task – New Magazine Launch
A 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.

15. Fill in this table…. Work column by column from left to right
Number of magazines per month
Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$2,000.00
$3,000.00
$4,000.00
$5,000.00
$6,000.00
$7,000.00
$8,000.00
Work column by column from left to right

16. Fixed Costs stay the same at ALL levels of output (in the SHORTRUN)
Number of magazines per month
Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$4,000
$2,000.00
$3,000.00
$4,000.00
$5,000.00
$6,000.00
$7,000.00
$8,000.00

17. TVC = VC per unit x Output
Number of magazines per month
Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$4,000
$3,000
$2,000.00
$6,000
$3,000.00
$9,000
$4,000.00
$12,000
$5,000.00
$15,000
$6,000.00
$18,000
$7,000.00
$21,000
$8,000.00
$24,000

18. TC = FC + TVC Number of magazines per month Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$4,000
$3,000
$7,000
$2,000.00
$6,000
$10,000
$3,000.00
$9,000
$13,000
$4,000.00
$12,000
$16,000
$5,000.00
$15,000
$19,000
$6,000.00
$18,000
$22,000
$7,000.00
$21,000
$25,000
$8,000.00
$24,000
$28,000

19. AC = TC Output Number of magazines per month Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$4,000
$3,000
$7,000
$7.00
$2,000.00
$6,000
$10,000
$5.00
$3,000.00
$9,000
$13,000
$4.33
$4,000.00
$12,000
$16,000
$4.00
$5,000.00
$15,000
$19,000
$3.80
$6,000.00
$18,000
$22,000
$3.67
$7,000.00
$21,000
$25,000
$3.57
$8,000.00
$24,000
$28,000
$3.50

20. Revenue = Selling Price x Output
Number of magazines per month
Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$4,000
$3,000
$7,000
$7.00
$5,000
$2,000.00
$6,000
$10,000
$5.00
$3,000.00
$9,000
$13,000
$4.33
$15,000
$4,000.00
$12,000
$16,000
$4.00
$20,000
$5,000.00
$19,000
$3.80
$25,000
$6,000.00
$18,000
$22,000
$3.67
$30,000
$7,000.00
$21,000
$3.57
$35,000
$8,000.00
$24,000
$28,000
$3.50
$40,000

21. Profit/Loss = Revenue - TC
Number of magazines per month
Fixed Costs
Total Variable Costs
Total Costs
Average Cost
Total Revenue
Profit/Loss
$1,000.00
$4,000
$3,000
$7,000
$7.00
$5,000
-$2,000
$2,000.00
$6,000
$10,000
$5.00 $0
$3,000.00
$9,000
$13,000
$4.33
$15,000
$2,000
$4,000.00
$12,000
$16,000
$4.00
$20,000
$5,000.00
$19,000
$3.80
$25,000
$6,000.00
$18,000
$22,000
$3.67
$30,000
$8,000
$7,000.00
$21,000
$3.57
$35,000
$8,000.00
$24,000
$28,000
$3.50
$40,000
Should the publishing company launch the magazine?

22. Questions……
At 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?

23. Clue to the next topic….

24. Breakeven Analysis

25. 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 = 15

26. Profit = Total Revenue – Total Costs
What 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 firm’s total revenue is equal to its total costs.
Profit = Total Revenue – Total Costs
Questions
Do 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 ?

27. Break Even Charts Costs/Revenue TR TC VC FC Output/Sales
The break even point occurs where total revenue equals total costs. The firm will have to produce and sell this number of units to breakeven
Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially.
Initially a firm will incur fixed costs, these do not depend on output or sales.
The lower the price, the less steep the total revenue curve.
As output is generated, the firm will incur variable costs – these vary directly with the amount produced. VC
The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC
Breakeven
Revenue FC
Breakeven
Output
Output/Sales

28. Break Even Charts – What they show
Costs/Revenue TR TC
Profit
Loss
Margin of safety
Breakeven
Output D2 D1
Output/Sales

29. Changes in Variable Costs
Costs/Revenue
TC1 TR TC
TC2
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?
The level of variable costs affects the gradient of the Total Costs line.
BEP2
BEP
BEP1
Output/Sales

30. Changes in Fixed Costs
Costs/Revenue
TC1 TR TC
TC2
If fixed costs go up, the Total Costs line will shift upwards
If fixed costs go down, the Total Costs line will shift downwards
The fixed cost line affects where the Total Cost line starts
BEP2
BEP
BEP1
Output/Sales

31. Changes in Selling Price
TR1
Costs/Revenue TR
TR2 TC
A decrease in the selling price will make the TR line less steep
A change in Selling price will affect the gradient of the Total Revenue line
An increase in the selling price will make the TR line steeper
BEP1
BEP
BEP2
Output/Sales

32. Questions
Explain what will happen to the Breakeven output in the following situations. Illustrate with a diagram.
The cost of raw materials increases
The company moves to premises with cheaper rent
The company decreases the selling price to compete with a new competitor
The electricity supplier increases their prices

33. Using Contribution to calculate the Breakeven Point
To calculate the breakeven point in terms of output the following formula can be used
Breakeven Output =
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 −𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡 (𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛)
How can we work out the Breakeven Revenue?
Multiply the Breakeven output by the Selling Price

34. Questions
Work 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 £8
Fixed Cost £89,000; Selling Price £99.99 Variable cost £67.31
Fixed Costs £1,000; Selling Price £1.75 Variable cost 93p

35. Answers £3,000/£3.75 = 800 units £6,400 £89,000/£32.68 = 2724 units
£272,372.76
£1000/£0.93 = 1220
£2,135