Question

Watch the excerpt from the movie "The Office / Broke." Respond to the following questions: 1. Explain the concepts of fixed cost, variable cost, and avoidable cost. 2. Assume a company has $200 in fixed costs, marginal costs are $10, and the company produces 100 units per year. How low can the price go before it is preferred to shut down

Answer 1

Answer:

Let's assume 100 units per year is the break even point (in units).

Break even point is that level of sales revenue which covers all of the costs involved i.e. fixed and variable costs both.

Hence, contribution = Fixed costs at Break Even Point

Contribution = Sales - Variable (Marginal) Costs           -      ( Part A )

Hence, Contribution = $ 200 i.e. fixed costs

Now,

$ 200 = Sales - $ 10 ( From Part A)

Sales = $ 210

Now, Shut down point is that that where the firm is just capable of meeting its variable costs from the sales it has earned (price earned).

Hence, the price can go till $ 10 from $ 210 i.e. $ 200 ( $ 210 - $ 10 ) below from the current level.

Hence, the price can go $ 200 down before it is preferred to shut down by the firm.

For 1st part answer refer to the Explanation.

Explanation:

(1) Fixed Costs

Fixed costs refer to the expenses which are always have to be incurred by the business irrespective of the level of output produced. For example, a firm has to pay rent on land on which it is operating , pay CEO's compensation for managing role in the organization (constant part), charge depreciation on production tools and equipments and pay cleaning staff fixed salaries , irrespective of the level of output produced.

(2) Variable ( Marginal costs)  

Variable costs are the costs which have a direct relation with the level of output produced by the firm. For example, the more the no. of units produced the more the labour charges paid, more the raw material payments made and the more the manufacturing related expenses etc and vice-versa.

(3) Avoidable costs

Avoidable costs are the costs which can be controllable i.e. the costs incurring can be avoided by the management. For example, when there is slowdown in the economy, growth and expansion costs can be avoided and production related costs can be cut (variable costs) etc.

For Part 2 answer refer to the "Answer" at the top of the entire solution.