Page 217 - Cambridge IGCSE Business Studies

16 Costs, scale of production

and break-even analysis

Introduction
Objectives
Businesses have to make many decisions. Most business decisions require managers
In this chapter you will
to have accurate data about the costs involved. In this chapter you will learn about
learn about:

the different ways of classifying costs.
■ the different classifications of

The classification of costs helps in business decision-making. You will learn how
business costs
the classification of costs is important when using the techniques of break-even
■ the usefulness of cost data in analysis. This is a technique that is used by many businesses when analysing the
business decision-making relationship between their revenue, costs and volume of output.
■ economies and diseconomies

You will also study the effect of the scale of production on business costs and how
of scale
these might change as a business grows.
■ break-even analysis.
How are costs classified?

The main classifications of cost are:

■ fixed costs
■ variable costs 215
■ total costs
■ average costs.

Fixed costs, variable costs and total costs are usually explained by linking them to
the level of a business’s output.

KEY TERMS Fixed and variable costs
Fixed costs do not change with output. In other words, a fixed cost will be the

Fixed costs: costs that do not
same amount when output is zero or when the firm is producing its maximum

change with output.

output – this is known as capacity. Good examples of a fixed cost are factory rent,
Variable costs: costs that
change in direct proportion or the salary of managers.
to output. Variable costs change with output. If output increases by 50%, then the
Total cost: all the variable and variable costs will also increase by 50%. A good example of a variable cost is
fixed costs of producing the total raw materials.
output. Total cost is all the costs of making a certain level of output. If the fi xed
costs of producing 2,000 units of output is $3,000 and the total variable costs of
producing 2,000 units is $5,000, then the total cost of producing 2,000 units is
$8,000 ($3,000 + $5,000).

Total cost = fi xed costs + total variable costs