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Economic Considerations

5.5.1 List the costs that contribute to the final cost of a product.

Take into account scale of production, complexity of product, resources, skills, quality control, size and weight of product for storage and distribution, type of advertising and marketing, profits and taxes. Include costs relating to availability and procurement of materials, R&D, labour, manufacturing costs, capital costs, overheads, distribution and sales

What makes a cost of a product what it s is a variety of factors. The cost of the product, or cost to produce it depends on whether the materials used are expensive or in-expensive, whether the product is simple or complex, whether the product is large or small, whether the product is mass reproduced or individually, custom-hand crafted.

The final (total) cost is made of of variable and fixed costs.

Cheap mass produced bic pen Expensive, hand-crafted Mont Blanc pen

5.5.2 Define fixed costs and variable costs.

Fixed Costs

The costs that must be paid out before production starts, for example, machinery. These costs do not change with the level of production.

Variable Costs

Costs that vary with output, for example, fuel or raw materials.

5.5.3 Identify the factors in 5.5.1 as fixed costs or variable costs.

The scale of production of a product will influence its fixed costs such as machinery. No matter the quantity produced, there will always be the same cost for the machine. Therefore, the more products one can produce at the same costs, the more the fixed cost per unit will decrease, which ultimately enables the company to enjoy economies of scale. These economies of scale are advantageous for a company because it can make them charge the same prices and increase profits per unit or it can decrease its product's price and consequently sell more of it, which also increases profit. Advertising and marketing is also an example of a fixed cost because no matter how many units a company sells of a product, the advertisement will always be the same price, i.e. it is not correlated with the increase/decrease of manufacturing. The rent of the premises and taxes are usually fixed costs too because the same amount/same proportion will be charged again every time interval. Fixed costs also include salaries and accounting costs.

Variable costs on the other hand are costs in direct correlation with the production. Examples are the wages of the workmen, since the more they work, the more they get paid. The costs of raw materials, sales and distribution are also examples of variable costs. Production costs such as the amount of materials used for manufacturing are also variable costs.

Fixed Costs Variable Costs
Scale of production, complexity of product, skills, quality control, type of advertising and marketing, R&D, capital costs, overheads. Labour, manufacturing costs, costs relating to availability and procurement of materials, profits and taxes, size and weight of product for storage and distribution, resources, distribution and sales.

5.5.4 Explain how the costs in 5.5.1 relate to craft production, mechanisation and automation.

For example, raw materials and labour costs will be significant for an individually crafted mahogany table, but for an injection-moulded plastic component these costs would be low and the capital cost of machinery high.
Craft production Mechanisation production Automation production
Labour Very significant Significant No so much
Raw Materials Very significant Significant Significant
Profits and taxes No so much Very significant Very significant
Storage and distribution No so much Very significant Very significant
Resources (energy) No so much Very significant Very significant
Capital costs No so much Very significant Very significant
Distribution and sales. No so much Very significant Very significant
Scale of production No so much Significant Very significant
Complexity of product No so much Significant Very significant
Skills Very significant Very significant Very significant
advertising and marketing No so much Very significant Very significant
R&D No so much Very significant Very significant
overheads.

5.5.5 Explain the concept of “break-even point” in relation to fixed and variable costs.

Once “break-even” point is reached, profits can be made, because fixed costs have been covered. Variable costs will continue to rise with increased production.

The break even point is the point at which the costs of both the fixed costs and the total variable costs are made up for by profit. As the fixed costs are constant and the variable costs increase with production, then there is a starting point for when exactly or after how many units sold/ produced will the business start to make profit, that point known as the "Break even" point. Yet keep in mind that after the break even point, the business will still have to cover variable costs that vary according to production and output of units.

Graph showing costs Graph showing costs

A proportion of the total of the fixed costs would be reflected in the the price of each product. The amount that the fixed costs contribute depends upon the break-even determined by the manufacturer.

All the variable costs to produce each product would be included in the cost in each product.


References

Bulleted list and italicised paragraphs are excerpted from Design Technology: guide. Cardiff Wales, UK: International Baccalaureate Organization, 2007.

Images are clickable links to its location.

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Page last modified on April 14, 2014, at 12:12 AM