Page 220 - Cambridge IGCSE Business Studies

Cambridge IGCSE Business Studies Section 4 Operations management

EXAMPLE

A business manufactures two products. The revenue, cost and profit data for each product is shown below.

Product A Product B Total
$000 $000 $000
Revenue 20 50 70
Fixed costs 10 15 25
Total variable costs 12 18 30
Total costs 22 33 55
Profit (2) 17 15

Table 16.1 Revenue, cost and profit data for the production of Products A and B

Note:

Profit is the difference between revenue – the amount a business earns from selling its products – and total costs.

We can see from the data in Table 16.1 that Product A has made a loss of $2,000.
The Marketing Manager thinks that the company should stop selling Product A,

Revenue: Chapter 21 page 268. but the company’s accountant disagrees. Who is right?
You have already learned that fixed costs do not change with output. Even when

output is zero fixed costs still have to be paid. So, if the company stops producing

218 Product A, it will still have to pay the fixed costs of $10,000. It will not have any

variable costs but will lose the revenue from the sales of Product A.
The amended data for each product and the company in total is shown below.

Product A Product B Total
$000 $000 $000
Revenue – 50 50
Fixed costs 10 15 25
Total variable costs – 18 18
Total costs 10 33 43
Profit (10) 17 7

Table 16.2 Revenue, cost and profit data for the production
of Products B only

We can see that if the company decides to stop producing Product A that profi t
will fall from $15,000 to $7,000. Therefore, the accountant is right to continue the

production of Product A. However, a business will not want to continue producing
a loss-making product forever. When a business no longer has the fixed costs of the

product then it will stop its production.

TEST YOURSELF
1 Using suitable examples, explain the difference between fixed costs and variable

costs.
2 What is meant by ‘average cost’?
3 How do you calculate average cost?