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O Level Business Studies Private Tuitions Education

Methods of pricing.
Cost plus pricing

Break-even can also be calculated without drawing a chart. A formula can be used:

Break-even level of production =Total fixed costs/ Contribution per unit

Contribution = Selling price – Variable cost per unit (this is the value added/contributed to the product when sold)

A break-even chart can be drawn, that shows the costs and revenues of a business across different levels of output and the output needed to break even

Break-even
Break-even level of output is the output that needs to be produced and sold in order to start making a profit. So, the break-even output is the output at which total revenue equals total costs (neither a profit nor loss is made, all costs are covered).

Diseconomies of scale are the factors that lead to an increase the average costs of a business as it grows beyond a certain size. They are:

Poor communication: as a business grows large, more departments and managers and employees will be added and communication can get difficult. Messages may be inaccurate and slow to receive, leading to lower efficiency and higher average costs in the business.
Low morale: when there are lots of workers in the business and they have non-contact with their senior managers, the workers may feel unimportant and not valued by management. This would lead to inefficiency and higher average costs.
Slow decision-making: As a business grows larger, its chain of command will get longer. Communication will get very slow and so any decision-making will also take time, since all employees and departments may need to be consulted with.
Businesses are now dividing themselves into small units that can control themselves and communicate more effectively, to avoid any diseconomies from arising

Scale of production
As output increases, a firm’s average cost decreases.

Economies of scale are the factors that lead to a reduction in average costs as a business increases in size. The five economies of scale are:

Purchasing economies: For large output, a large amount of components have to be bought. This will give them some bulk-buying discounts that reduce costs
Marketing economies: Larger businesses will be able to afford its own vehicles to distribute goods and advertise on paper and TV. They can cut down on marketing labour costs. The advertising rates costs also do not rise as much as the size of the advertisement ordered by the business. Average costs will thus reduce.
Financial economies: Bank managers will be more willing to lend money to large businesses as they are more likely to be able to pay off the loan than small businesses. Thus they will be charged a low rate of interest on their borrowings, reducing average costs.
Managerial economies: Large businesses may be able to afford to hire specialist managers who are very efficient and can reduce the business’ costs.
Technical economies: Large businesses can afford to buy large machinery such as a flow production line that can produce a large output and reduce average costs.

Costs, Scale of Production and Break-even Analysis

Costs
Fixed Costs are costs that do not vary with output produced or sold in the short run. They are incurred even when the output is 0 and will remain the same in the short run. In the long-run they may change. Also known as overhead costs.
E.g.: rent, even if production has not started, the firm still has to pay the rent.

Variable Costs are costs that directly vary with the output produced or sold. E.g.: material costs and wage rates that are only paid according to the output produced.

TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

TOTAL COST = AVERAGE COST * OUTPUT

AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT