Economics (NCERT) Notes

4.7 Break-Even Point and Opportunity Cost

Break-even point 
•Break-even point  can be defined as a point where total costs (expenses) and total sales (revenue) are equal.
•It is a point where there is no net profit or loss.
•It is the point where the total cost and the total revenue curves meet.
•The point on the supply curve at which a firm earns only normal profit is called the break-even point of the firm.
•The point of minimum average cost at which the supply curve cuts the LRAC curve (in short run, SAC curve) is the break-even point of a firm.
 
Importance of Break even value
•The break-even value is not a generic value and will vary dependent on the individual business.
•Some businesses may have a higher or lower break-even point.
•Break-even point calculation enable firms to see the number of units they need to sell to cover their variable costs.
•Each sale will also make a contribution to the payment of fixed costs as well.
 
Example of break even value
•Let a business needs to make annual sales of 200 tables to break-even.
•At present the company is selling fewer than 150 tables and is therefore operating at a loss.
•As a business, they must consider increasing the number of tables they sell annually in order to make enough money to pay fixed and variable costs.
 
Strategy of manage Break-even
•If the business does not think that they can sell the required number of units, they could consider the following options:
     1. Reduce the fixed costs. This could be done through a number or negotiations, such as reductions in rent payments, or through better management of bills or other costs.
     2. Reduce the variable costs, (which could be done by finding a new supplier that sells tables for less).
•Either option can reduce the break-even point so the business need not sell as many tables as before, and could still pay fixed costs.
 
Opportunity cost
•Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another.
•We can use it to make educated decisions when they have multiple options before them.
•In economics, opportunity cost of some activity is the gain foregone from the second best activity.
 
Example of Opportunity Cost
•Suppose you have Rs 1,000 which you decide to invest in your family business.
•What is the opportunity cost of your action?
•Other Alternatives
     •keep it in the house-safe which will give you zero return
     •deposit it in either bank-1 or bank-2 in which case you get an interest at the rate of 10 per cent or 5 per cent respectively.
•So the maximum benefit that you may get from other alternative activities is the interest from the bank-1.
•However, this opportunity will no longer be there once you invest the money in your family business.
•The opportunity cost of investing the money in your family business is therefore the amount of forgone interest from the bank-1.



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