Week 2: Class work

1. Calculate the cost of a skateboard if the total fixed costs are $30,000 and variable costs
are $60,000 to produce 1,500 skateboard.

Total cost = Fixed Cost (FC) + Variable Cost (VC)

$90,000 / 1,500 = $60

2. What is the profit per skateboard, if the sales price is $120 per skateboard?

Profit= Sales Price – Total Cost

$120 - $60 = $60

3. Extension activity: What is the break-even point if the sales price is $120 per skateboard (i.e.
how many skateboards do I need to produce to have a $0 loss)?

1. Break-Even Point in Units = Fixed Costs / Contribution Margin

2. * Sales Price per unit - Variable Costs per unit = Contribution margin
3. Variable Costs Per Unit = $60,000/1,500 = $40
4. Contribution margin = $120-$40 = $80

Break-even point = fixed costs ÷ contribution margin

= $30,000/$80

=375 unit
I.e. 375 units need to be sold before a profit is made.

4. Explain what is meant by economies of scale (Q1 page 4)

Provide a definition:
The cost per unit of output is lower due to operating on a larger scale. When a lot is
produced, a unit is produced more cheaply.

Economies of scales explained:

When 3,000 skateboards are produced what will the cost be?
Fixed cost remains fixed = $30,000
Variable cost increases in line with the amount of products produced:
$60,000 / 1,500 = $40
Thus, when 3,000 skateboards are produced VC increases to $40 x 3,000 = $120,000
Total cost = $30,000 (FC) + $120,000 (VC)
= $150,000
 New unit cost per skateboard = $150,000 / 3,000
= $50

There is a $10 saving.

Economies of scale was achieved due to an increased production volume (1,500 more skateboards
were produced) at the SAME fixed cost of $30,000.

Fixed cost to produce 1,500 skateboards = $30,000/1500 = $20

Fixed cost to produce 1,500 skateboards = $30,000/3000 = $10

At some point of increased production volume the fixed cost will increased due to increased
employees, additional equipment, increased facility needs, etc.

‘In economics, a cost curve is a graph of the costs of production as a function of total quantity
produced. In a free market economy, productively efficient firms use these curves to find the
optimal point of production (minimising cost), and profit maximising firms can use them to decide
output quantities to achieve those aims. There are various types of cost curves, all related to each
other, including total and average cost curves, and marginal ("for each additional unit") cost
curves, which are equal to the differential of the total cost curves. Some are applicable to
the short run, others to the long run’. (Wikipedia: https://en.wikipedia.org/wiki/Cost_curve)

LRAC = Long run activity cost

What are the potential benefits of economies of scale?

Saving money, bulk buying result into lower input cost (e.g. Material), Lower energy input cost,
Lower cost of finance, lower cost of transport (e.g. transporting one unit is much more expensive
than transporting a 1000 items that can all share the cost), lower advertising cost

Multiple choice:
Economies of scale can lead to increased profits for large companies because:
a. They can do competitive deals on their advertising
b. They can buy inputs for their production processes more cheaply
c. They can afford to undertake extensive research on markets and products
d. All of the above
Answer: D