Assignment: 2

Subject: Managerial Economics

Submitted By: Fizza Khan
Submitted To: Ma’am Saima Sajad
Semester: 5th
Analysis in detail.
Date: 23-05-23
Department: Management Sciences
Topic:
Q1) Differentiate between the following terms
i. Explicit and Implicit costs
ii. Incremental and Sunk costs
iii. Economies of Scale and Economies of Scope
Q2) Explain the Breakeven Analysis in detail
Contents

Difference between Explicit and Implicit Costs:.........................................................................................2

Difference between incremental and Sunk costs..........................................................................................3
Difference between Economies of scale and Economies of Scope..............................................................4
Breakeven Analysis.....................................................................................................................................5
Question No 1:
Differentiate between the following terms
1: Explicit and Implicit costs
2: Incremental and Sunk costs
3: Economies of scale and Economies of scope
Answer:

I. Difference between Explicit and Implicit Costs:

Explicit Cost Implicit Costs

Definition: Definition:
Explicit costs refer to the actual, out-of-pocket Implicit costs, also known as opportunity costs,
expenses that a business incurs and for which represent the value of resources or
monetary payment is made to acquire opportunities that are forgone or sacrificed
resources or services. when a particular course of action is chosen.
Nature: Nature:
These costs involve clear, measurable, and These costs are not actual cash outflows but
direct cash outflows from the company. rather the value of alternative options that are
given up.

Examples:
Wages and salaries, rent or lease payments,
utility bills, raw materials and supplies,
advertising expenses, taxes, and interest
payments are all examples of explicit costs.
Record-keeping:
Explicit costs are recorded in the company's
financial statements, such as the income
statement, and can be easily tracked in the
general ledger.
Impact on Profitability:
Examples:
Implicit costs can include the foregone income
from alternative uses of the owner's capital, the
value of personal time or effort contributed by
the owner, the rental income that could have
been earned from a property owned by the
business, or the returns that could have been
gained by investing capital elsewhere.
Record-keeping:
Implicit costs are not recorded in the financial
statements because they do not involve direct
monetary transactions. However, they are
important considerations for decision-making
and assessing the true cost of a particular
action.
Impact on Profitability:
Explicit costs directly impact a company's
profitability by reducing its net income. They
are deducted from the company's revenue to
determine the net profit or loss
Measurement:
The measurement of Explicit Cost is objective
because it is actually incurred.
Implicit costs are not deducted from revenue
when calculating net income. However, they
still have an impact on a business's profitability
by influencing the opportunity cost of using
resources in a particular way.
Measurement:
Implicit Cost occurs indirectly, which is why its
measurement is subjective.

II. Difference between incremental and Sunk costs

Incremental Cost Sunk costs

Definition: Definition:
Incremental costs, also known as differential Sunk costs are costs that have already been
costs, are the additional costs that are incurred incurred and cannot be recovered or changed
when a business makes a specific decision or regardless of future decisions or actions.
takes a particular course of action.
Nature: Nature:
These costs represent the change in total costs These costs are historical or past expenses that
between two alternative options or scenarios. are irrelevant to current and future decision-
making because they are no longer avoidable.

Incremental costs are closely related to the The Sunk costs are those which cannot be
concept of Marginal cost but with a relatively altered, increased, or decreased, by varying the
wider connotation. rate of output.

Incremental costs arise due to the change in They cannot be revised or reversed or
product lines, addition or introduction of a recovered when there is a change in market
new product, replacement of worn out plant conditions or change in business decisions.
and machinery, replacement of old technique
of production with a new one, etc.
Example: Examples:
If a company is deciding whether to introduce Costs such as equipment or machinery that has
a new product, the incremental costs would been purchased and cannot be returned,
include the additional costs associated with research and development expenses for a
manufacturing, marketing, distribution, and failed project, or training costs for employees
 any other expenses directly related to the new who have already left the company are all
product examples of sunk costs.

III. Difference between Economies of scale and Economies of scope

Economies of Scale Economies of Scope:

Definition: Definition:
Economies of scope refer to the cost
Economies of scale refer to the cost advantages that a company can achieve when
advantages that a company can achieve when it produces multiple products or offers a
it increases the scale or volume of range of services using shared resources or
production. capabilities.
Nature: Nature:
These cost advantages arise from the ability
These cost advantages result from spreading to leverage common resources, knowledge,
fixed costs over a larger output quantity, technology, or distribution channels across
leading to a reduction in the average cost per different products or services.
unit produced.
Cost Reduction: Cost Reduction:
Economies of scope allow companies to
Economies of scale enable businesses to reduce their overall costs by sharing
reduce their per-unit production costs as they resources, such as production facilities,
increase their production levels. marketing efforts, research and development,
or distribution networks among different
product lines or service offerings.
Factors: Factors:
Economies of scope can be realized through
Economies of scale can be achieved through factors like cross-selling opportunities,
various factors, such as increased shared research and development costs,
specialization, improved resource allocation, utilizing the same production equipment for
bulk purchasing discounts, efficient use of different product lines, or using the same
machinery, and the ability to negotiate better distribution channels for multiple products.
pricing with suppliers.
Example: Example:
A diversified company that produces
A manufacturing company that expands its multiple products and benefits from shared
production capacity and experiences lower manufacturing facilities, joint marketing
 campaigns, or the ability to offer bundled
average production costs due to increased packages is an example of economies of
efficiency, reduced unit costs of raw scope.
materials, and better utilization of machinery
is an example of economies of scale.

Question No 2:
Explain Breakeven Analysis in detail.
Answer:

Breakeven Analysis
Break-even analysis is a financial tool used by businesses to determine the point at which total
revenue equals total costs, resulting in neither profit nor loss. It provides insights into the
minimum level of sales or production volume required for a business to cover its expenses.

Basic Components:
Fixed Costs:
These are costs that do not change with the level of production or sales. Examples include rent,
salaries, insurance, and equipment depreciation.
Variable Costs:
These costs vary directly with the level of production or sales. They include raw materials, direct
labor, and sales commissions.
Total Costs:
The sum of fixed costs and variable costs.
Revenue:
The income generated from sales of products or services.

Break-even Point:
i. The break-even point is the level of sales or production where total revenue equals total
costs.
ii. At this point, the business neither makes a profit nor incurs a loss.
iii. It can be expressed in terms of the number of units sold or the revenue generated.
Break-even Analysis Formula:
 Break-even Point (in units) = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)
 Break-even Point (in revenue) = Break-even Point (in units) x Selling Price per Unit

Importance and Uses of Break-even Analysis:

Assessing Profitability:
Break-even analysis helps determine the minimum sales volume needed to cover costs and
achieve profitability.
Pricing Decisions:
It provides insights into the impact of changing prices on the break-even point and helps in
setting appropriate pricing strategies.
Cost Control:
By understanding fixed and variable costs, businesses can identify areas where cost reductions or
efficiency improvements are required.
Investment Decisions:
Break-even analysis is useful when evaluating the viability of new projects or investments by
assessing their potential to reach the break-even point.
Sensitivity Analysis:
It allows businesses to understand how changes in costs, prices, or volume impact their
profitability and helps in making informed decisions.

Limitations of Break-even Analysis:

Simplified Assumptions:
Break-even analysis relies on assumptions of fixed costs, constant selling prices, and linear
relationships between costs and volume, which may not hold true in all situations.
Ignoring Non-financial Factors:
It focuses solely on financial aspects and does not consider factors like market demand,
competition, and qualitative aspects affecting business performance.
Lack of Precision:
Break-even analysis provides estimates based on average cost and price figures, and it may not
account for variations across different products or services.