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  C:\Documents and Settings\dconarroe\My Documents\My Videos\the firm 1 soft drinks.mpg C:\Documents and Settings\dconarroe\My Documents\My 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

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.

Marginal Cost Curve for Con’s Kitchen

Average and Marginal Cost Curves for Con’s Kitchen

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  Total Revenue = Price x Quantity Sold  Price can be raised or lowered to change revenue price elasticity of demand important here  If it is elastic and we raise price, revenue drops  If it is elastic and we lower price, revenue increases  If it is inelastic and we raise price, revenue increases  If it is inelastic and we lower price, revenue drops Different pricing strategies can be used  penetration, psychological, etc. Quantity sold is a function of price and demand  Demand  Is the market We can sell more at the same price, thereby increasing revenue Is influenced by amending the elements of the marketing mix  The 7 Ps

Marginal Revenue  Marginal Revenue.ppt Marginal Revenue.ppt