18

Costs, scale of production

and break-even analysis
Revision answers
1 i) To calculate an appropriate selling price, for example, the manager will want
the price to be higher than the cost of making the product.
ii) To calculate profits/losses by comparing with the revenue earned during a
period of time.
Other answers possible.
2 For example, cost of the equipment used in the factory. This will not vary with
the number of cars produced in any one time period.
3 Wool is one of the material costs in making carpets. The more carpets produced,
the higher will be the cost of the wool bought in.
4 Line from origin (0) is sales revenue. Sloping line from fixed costs (F) is total cost.
Vertical axis is $ (costs/revenue) and horizontal axis is units of output.
5 a) 6000 units
b) 1500 units
6 Break-even output = fixed costs/contribution per unit
= $40 000/8 cents per brick
= 500 000 bricks
7 Break-even output could be reduced by:
l increasing price
l cutting fixed costs
l cutting variable costs.
8 A lower break-even output increases the margin of safety; it increases the range
of profitable output and will usually lead to higher profit.
9 i) The charts allow managers to forecast likely profit levels at different levels of
output.
ii) They allow managers to suggest changes, for example, higher or lower prices
and to see what happens to the break-even point and profits if this change is
made.
10 i) They assume that all products made will be sold; no inventories held.
ii) They assume that sales revenue and variable costs vary directly with output.
This might not be the case if, for example, the price has to be reduced to
increase sales.
11 Total cost is the sum of variable costs and fixed costs at a particular level of
output.
12 Average cost = total costs/output.
The cost of producing each unit; also known as unit cost.
13 i) Purchasing/bulk buying economies
ii) Financial economies
iii) Managerial economies
Other answers possible.
14 i) Poor communication between branches or branches and head office.
ii) Lack of staff motivation if they feel unimportant working for a larger
business.

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 18 Costs, scale of production and break-even analysis

Answers to activities
Activity 18.1
Student’s own answer.

Activity 18.2
l Fixed: rent; insurance; bank fees; management salaries.
l Variable: raw materials.
Student’s own answer for other costs.

Activity 18.3
a) Y = $24 million; Z = $14 million
b) Y = $36 million; Z = £20 million
c) Y = $3000; Z = $4000
d) The managers can compare these unit costs and use them to set different prices
for these two models. If they think that Z is too expensive to produce compared
with Y then they might try to cut these production costs.

Activity 18.4
l Able to bulk buy raw materials, for example, clay used to make bricks more
cheaply.
l Able to obtain lower interest rate loans from banks as they believe the business is
now safer and less risky.
l Able to recruit specialist managers to operate each department and division, for
example, production and marketing.

Activity 18.5
a) A = $200 000
B = $3 850 000
b) A = $10
B = $5.5
c) Economies of scale such as purchasing, technical, managerial. Explain in the
context of a much larger factory.
d) Lower average costs will allow Company B to charge lower prices and gain a
competitive advantage; if Company B keeps its prices quite high it will make
higher profits per product than Company A.

Activity 18.6
a) x = $30 000
y = $30 000
z = 0
a = $50 000
b = $80 000
b) Student’s own answer.
c) If you have drawn the chart correctly then:
Break-even level of output: 6000 units
Level of profit at maximum output: $20 000

Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 2
 18 Costs, scale of production and break-even analysis

Activity 18.7
a) Student’s own answers
b) i) BE = 6000 units
ii) 1500 units
iii) $3000
c) Profit up to $12 000 and break-even down to 3000 units.
d) The business might not be able to sell the same number of units following an
increase in price. It depends on the price elasticity of demand.

Activity 18.8
a) 900 meals
b) $2400
c) 1200 meals

Sample answers to Paper 1 style questions

(with mark annotations for Question 2)
1 a) Costs that change with the number of units produced/level of output.
b) i) Market stall rent
ii) Insurance on stock of jewellery
c) i) She could move to a cheaper market with lower rent costs.
ii) She could pay her sales assistant less for each item sold but keep the
selling price the same.
d) i) Large manufacturers could buy gold, gems and other raw materials at a
slightly lower price if they bought in large quantities.
ii) Larger firms could afford specialised and efficient machines rather than
simple tools to shape jewellery to increase output per worker.
e) Yes: more convenient and safer for customers; creates a better image for her
business and jewellery; might be able to charge higher prices, for example, if
the shop is near city centre.
No: higher fixed costs will increase break-even level of sales; may have to
recruit more staff at higher wage costs; the type of jewellery she sells might
be more suited to customers who shop in a market.
Overall conclusion/judgement needed.
2 a) Costs that do not change as output rises or falls. [2K]
b) i) Fruit used in drinks.
ii) Electricity costs of operating drink production machinery. [2App]
c) i) Diseconomies of scale such as poor communication in a large business can
result in higher average costs. [1K; 1An]
ii) Workers can lack motivation in a big business as they feel unimportant.
[1K; 1An]

Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 3
 18 Costs, scale of production and break-even analysis

d)
Sales
revenue
6

Profits ($2m)

$m Costs revenue
4 Break
even Total costs

2
Fixed costs
Variable
costs

0
1 2 3 4
Output units (m)
e) i) Raise prices of soft drinks: higher prices will increase the contribution
made from each drink and this will reduce the break-even point. BUT this
could reduce demand for Popsquash drinks too much and revenue might
actually fall.
ii) Lower fixed costs by locating in a cheap area away from a town but there
might be a shortage of workers in such an area and Popsquash might have
to pay higher wages to attract enough workers to the factory.
Other answers possible.
Student’s overall conclusion. [1K; 1App; 2An] + [2Eval]

Answers to revision test

 1 2)
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 6 3)
 7 2)
 8 2)
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10 3)
11 4)
12 1)
13 3)
14 4)
15 2)
16 3)

Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 4