Types of cost
Every business faces costs when it produces. Fixed costs do not change with the level of output in the short run — rent, insurance and salaries must be paid even if nothing is made. Variable costs change directly with output, such as raw materials and wages paid per item. Adding them gives total cost.
Key idea
Total cost = fixed costs + variable costs. Average cost (cost per unit) = total cost ÷ number of units. Contribution per unit = selling price − variable cost per unit.
Break-even
The break-even point is the level of output where total revenue exactly equals total cost, so the business makes neither profit nor loss. Below it there is a loss; above it there is profit. It shows the minimum a firm must sell to survive.
Key idea
Break-even output = fixed costs ÷ contribution per unit.
Example
Fixed costs are RM4000. A product sells for RM20 and costs RM12 in variable costs, so contribution is RM8. Break-even = 4000 ÷ 8 = 500 units. Any sales above 500 units earn profit.
Economies and diseconomies of scale
As a firm grows, economies of scale can lower the average cost per unit — for example buying materials in bulk at a discount, or spreading the cost of machinery over more units. If a firm becomes too large it may suffer diseconomies of scale, where poor communication and weaker control push average costs back up.
Remember
- Fixed costs stay the same as output changes; variable costs rise with output.
- Contribution = price − variable cost per unit.
- Break-even output = fixed costs ÷ contribution per unit.