"Easymap" is a minor niche company producing computer mouse-pads, which are constructed in a manner that protects the mouse from collecting dirt or dust. This company's product is based on the principle that a clean mouse is fast mouse. These mouse-pads are a hit among young gamers.
Easymap has fixed costs of 400,000 DKK a year, which include rent, interests/ depreciation of machinery, management salaries, etc. Furthermore, Easymap has the following variable costs per mouse-pad produced:
- 1 DKK in materials
- 30 0re in electricity for machinery, repair and maintenance, sales commission etc.
- 3 DKK for salaries within normal working hours
- 6 DKK for salaries outside normal working hours
Variable costs within normal working hours: 4.30 DKK per unit
Variable costs outside normal working hours 7.30 DKK per unit
It is possible to produce 60,000 mouse-pads within normal working hours. Overtime allows for the production of an additional 20,000 mouse-pads.
Costs shown mathematically
The cost functions are defined in order to create a general view of the costs involved in mouse-pad production. All cost functions are based on the TC function;
TC = 4.30Q + 400,000 representing the interval from 0-60,000 units produced TC = 7.30Q + 220,000 representing the interval from 60,001-80,000 units produced
Based on the TC function, the TFC function and the TVC function are determined. This process is made possible by the fact that the fixed costs do not vary with production and are therefore not affected by Q:
TFC = 400,000 regardless of the activity level
TVC = 4.30Q from 0-60,000 units
TVC = 7.30Q - 180,000 from 60,001-80,000 units
The average functions are determined when the total functions are divided by Q:
ATC = 4.30 + 400,000/Q from 0-60,000 units ATC = 7.30 + 220,000/Q from 60,001-80,000 units
AFC = 400,000/Q regardless of the activity level
AVC = 4.30 from 0-60,000 units
AVC = 7.30 - 180,000/Q from 60,001-80,000 units
The MC function is determined when the TVC function (or the TC function) is differentiated:
MC = 4.30 from 0-60,000 units
MC = 7.30 from 60,001-80,000 units
The cost functions are illustrated in figure 2.2.1 and 2.2.2:
Costs shown graphically
The Printing House
The Printing House
The Printing House specializes in fashion magazines. They are located in Viborg and have 3 employees. The company has annual fixed costs totaling 600,000 DKK, which include rent, interest, and installments paid on their printing machine, and insurances, etc. The cost of printing a fashion magazine is about 3 DKK, which includes materials, production worker wages, directly applicable electricity, etc. At this time, it is possible to print about 300,000 fashion magazines annually. The firm has the possibility of expanding production capacity by investing in a new and larger printing machine, which would cost 250,000 DKK. By replacing the printing machine the production capacity would be expanded to 700,000 fashion magazines annually. Simultaneously the costs of printing would decrease to 2.25 DKK per unit.
The Printing House would like to know what the costs are as related to different activity levels, which are especially relevant for their pricing considerations. For this reason, cost functions, which express cost as a the measurement function, are determined. The measurement unit, which defines the activity level, is the number of magazines printed.
As mentioned earlier, the firm has annual fixed costs of 600,000 DKK. The variable costs are 3 DKK per magazine from 0-300,000 fashion magazines a year, and 2.25 DKK from 300,001-700,000 magazines a year. Total costs can therefore be described as seen below:
TC = 3Q + 600,000 from 0-300.000 fashion magazines per year
TC = 2.25Q + 1,075,000 from 300.001-700.000 fashion magazines per year
Based on the above information, the total variable costs (TVC) and the total fixed costs (TFC) are determined. TVC varies with production though TFC does not.
TVC = 3Q from 0-300.000 fashion magazines per year
TVC = 2.25Q + 475,000 from 300.001-700.000 fashion magazines per year
TFC = 600,000 regardless of activity level.
Based on TC, TVC, and TFC the average total costs (ATC), the average variable costs (AVC), and the average fixed costs (AFC) are found when the total cost functions are divided by Q:
ATC = 3 + 600,000/Q from 0-300,000 fashion magazines per year
ATC = 2.25 + 1,075,000/Q from 300,001-700,000 fashion magazines per year
AVC = 3 from 0-300,000 fashion magazines per year
AVC = 2.25 + 475,000/Q from 300,001-700,000 fashion magazines per year
AFC = 600,000/Q regardless of activity level
The marginal costs (MC) are deduced by differentiating the TVC function (or the TC function, as the constant will always be neutralized). The marginal costs are described below:
MC = 3 from 0-300,000 fashion magazines per year
MC = 2.25 from 300,001-700,000 fashion magazines per year
Graphics presentation of the cost functions
The costs are shown in figure 2.3.1 and 2.3.2:
Weakness of the cost functions
The weakness of the cost functions is that they do not consider the cost complexity. Understanding that a function cannot reflect the complex conditions of the firm is important. However, cost functions can, if they are drawn up in a sensible way, be a useful tool for decision makers.
The complicating factors include: Motivation, planning, production levels for other products, general market conditions, general employment conditions, etc. There are both internal and external conditions that complicate these terms.
Case 2.4: Cost complexity
When a restaurant's master chef is about to price a dinner party, several factors are considered. One of these factors is the table setting. Even though setting the table is a simple process, it is actually quite difficult to establish exactly how much it will cost before the tables are set. That the costs are difficult to establish in advance is owing to the following factors:
o The special wishes of the party (arrangement of the tables, table dressing, napkins, flowers, table decorations, and candles etc.) vary from party to party, which results in that the costs varying from party to party.
o The wages used on the table setting depend on whether the employees have a good or a bad day, the time of the table setting (when the tables are set in the morning it happens a lot faster than in the evening), who is on the job, etc.
o The wages spent on ordering table dressings, napkins, decorations, flowers, and candles, depend on whether the supplier that was reached first is able to supply everything, or if alternative suppliers have to be reached. It also depends on whether the supplier has the relevant information about inventory on his computer or if he has to ask about the available inventory (which results in waiting time and additional phone calls)
The master chef at Bowl'n'Fun in Viborg, Kim Bülow Mortensen, says:
"It is almost impossible to know how much it generally costs to set a table for a party of, lets say 100 people, before the table has been set. I have to know a lot of things before I can make a qualified answer. A bowling center is such a dynamic entity that plans often have to be changed; i.e. under optimal conditions I can have the tables set for about 12 DKK per person, but I run the risk that they have to be set in the last minute, with tired waiters working over time. In this situation, it may cost up to 20 DKK per person attending the party. That is why it is difficult to establish the costs in advance"