Classify costs: fixed, variable, total
Fixed costs (FC) do not change with output in the short run - rent, insurance, manager salaries, loan interest. Variable costs (VC) rise directly with output - raw materials, packaging, piece-rate wages. Total cost combines them: total cost = fixed costs + (variable cost per unit x output). As output rises FC stays constant in total while VC rises, so total cost rises. Learn this - not every formula is printed on the exam.
Contribution and break-even output
Contribution per unit = selling price - variable cost per unit (the VARIABLE cost, never total or average cost). Each unit sold first helps pay the fixed costs; once they are covered, further contribution becomes profit. Break-even level of output = fixed costs / contribution per unit. Example: fixed costs £4000, price £9, variable cost £5, so contribution is £4 and break-even is 4000 / 4 = 1000 units. Below 1000 units the firm makes a loss, above it a profit.
Reading a break-even chart
A break-even chart plots total revenue and total cost against output. The total-revenue line starts at the origin, sloping up at the selling price. The total-cost line starts at the fixed-cost level (paid even at zero output), sloping up at the variable cost per unit. Where the lines cross is the break-even point: left of it a loss, right of it a profit. Read the break-even output from the horizontal output axis, not the money axis.
Drawn from real examiner reports.
Revenue is not profit
Revenue (sales, turnover) = selling price x quantity sold - the money coming IN, before any costs. Profit = total revenue - total cost. A firm with £13,500 of revenue has NOT made £13,500 of profit; the total cost must still be taken off. Do not treat the sales figure as the profit the firm keeps.
Contribution uses variable cost only
Contribution per unit = selling price - variable cost per unit - the VARIABLE cost only, never total or average cost. Subtracting total cost instead does not give contribution and feeds a wrong figure into break-even. Since break-even output = fixed costs / contribution per unit, a wrong contribution gives a wrong break-even.
Break-even output is units, not money
The break-even answer is a number of UNITS (a level of output), not a money value: it is fixed costs / contribution per unit, so the result is units. On a chart, read it off the horizontal output axis, not the vertical money axis. Break-even revenue (break-even output x selling price) is a separate money figure - do not give it when output is asked for.
Fixed vs variable cost mix-up
Rent, insurance, manager salaries and loan interest are FIXED - they do not change with output. Raw materials, packaging and piece-rate wages are VARIABLE - they rise as output rises. Giving a variable cost when a fixed one is asked for (or the reverse) loses easy marks. If the total stays the same as output changes it is fixed; if it rises it is variable.
Discount: subtract it from the price
In a discount calculation, a frequent slip is to work out the discount but forget to take it off the full price. A 10% discount on a £40 price is £4, but the price paid is £40 - £4 = £36, not £4. Check whether the question wants the discount or the new price, and finish the subtraction. Showing both steps protects the method marks.
November 2024 Paper 2 Q1(e): a frequent slip was to compute the discount but forget to subtract it from the full price.
Divide by contribution, then round up
Two errors cluster on the break-even formula. First, dividing fixed costs by the selling PRICE instead of contribution per unit - always divide by contribution (price - variable cost). Second, when the division is not exact, rounding DOWN: at the rounded-down figure fixed costs are not quite covered, so the firm still makes a loss. Round UP to the next whole unit.
A break-even chart is only a model
A break-even chart is a simplified model, not an exact forecast. It ASSUMES every unit produced is sold (some may go unsold, so the real break-even is higher), the selling price stays constant (firms often cut price to sell more), and the variable cost per unit stays constant (ignoring bulk discounts). State these assumptions before trusting a break-even decision.
Learn the formula and show working
Not every formula is printed - the cost, contribution and break-even formulae must be recalled; those who could not recall break-even could not start. Show working too: a method mark is there for the right formula and substitution even if the figure is wrong.
Give the answer in the form asked
Answer exactly what is asked, in the form asked. Break-even is a number of units, not a money figure. Where a money answer is wanted to two decimal places, round to two - a right value in the wrong form loses the mark. Write it clearly on the answer line.
Justify vs Evaluate: reach a judgement
Extended questions lose the most marks - the AO4 judgement. Analyse builds a chain of reasoning; Evaluate and Justify must add a decision. On a 9-mark Justify choose ONE option and say why it wins; on Evaluate weigh both sides and conclude. No decision stays mid-band.
Every business has costs, and you must be able to classify them and calculate total cost.
| Cost | What it is | Examples | As output rises... |
|---|---|---|---|
| Fixed costs (FC) | do not change with output (short run) | rent, insurance, manager salaries, loan interest | total stays the same |
| Variable costs (VC) | change directly with output | raw materials, ingredients, packaging, piece-rate wages | total rises |
| Total cost (TC) | fixed costs plus variable costs | — | rises (because VC rises) |
Full notes, flashcards, Q&A and the topic quiz for every premium subject.
Premium plans are US$8.99/month or US$49.99/year — first month free.
Studying with a parent's blessing? Show them this.
