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Breakeven (HL only)

Introduction

This lesson focuses on breakeven.  Previously this unit of the syllabus included shut down points, which is no longer part of the new syllabus.

Enquiry question

What is the difference between a firms breakeven point and the point that businesses will be forced to shut down in both the short term and the long run.

Teacher notes

Lesson time: 45 minutes

Lesson objectives:

Explain, using a diagram, when a loss-making firm would shut down and exit the market in the long run.

Calculate the breakeven price from a set of data.

Teacher notes:

1. Beginning activity - begin with the opening question and allow 5 minutes for discussion.

2. Processes - technical Vocabulary - the students can learn the key concepts through the handout which should take 10 minutes to go through and discuss. (10 minutes)

3. Paper three practise activities - included in the handout. (15 minutes)

4. Video of the world's richest ever company - start by asking your classes who they believe was the richest ever family / business and then show the video.  Allow 15 minutes for the video and discussion - how did the business become the world's most successful business and would this be possible now.  Ask your students to consider the part of the video about monopoly legislation when answering this, legislation that was not in place when Rockerfeller started his business.

Beginning question

1. If you owned a business that was losing money would you continue operating? 

The answer probably depends on how big is the loss and for long?  Is there an expectation that the business will make profits in the future?  In economics we make a distinction between the level of output needed to break even and the level required to stay in business.

Key terms:

Break-even point: TR = TC or AR = AC

  The class handout is available as a PDF file at:  Normal profit

Activities

Watch the following short power point presentation and then answer the following short questions which follow.

Available at: Breakeven

Activity 1

Imagine that you are starting a business with your friends.  So firstly imagine what that business would be and then secondly what is the minimum level of profit that you would accept from the business?  This should be equal to the wage that you would be able to make should you quit school and work somewhere else.  Answer the following short questions as a revision exercise.

Your sales revenue in year 1 is $ 45,000 of which $ 20,000 is spent on leasing a workshop.  The lease on this will last two years.  You also spend $ 5,000 on a one off production machine which is also estimated to last two years.  You also spend $ 25,000 on production materials and you estimate your minimum required profit level to be $ 15,000.

1. Are you making a profit or not?

Clearly not, including your opportunity cost your losses in year 1 are $ 7,500.

2. Will you shut this business down or keep it operating?

You would keep the business operating for at least one more year until the machine and lease that you purchased are finished.  These are fixed costs that have already been spent and closing the business down will not bring this money back.  Staying in business for one more year will only cost the variable costs of $ 25,000, plus your expected profit of $15,000.  In this case your sales revenue is more than sufficient to cover this.  

In one years time, however, when your machinery and work space are expired you will presumably close down the business, unless your revenue improves.  

Activity 2

1. (a) Calculate the break-even point for the following firm:

Fixed costs $ 80,000, raw material costs per unit $50 and selling price = $100.

The break even point is 1,600 units.

(b) What is the level of economic profit made at the following output levels - 1,000 units, 1,600 units, 3,000 units, 4,000 units.

Profit can be calculated by PQ minus FC so the profit figures are as follows:

1,000 units = - $30,000

1,600 units = $ 0

3,000 units = $ 70,000

4,000 units = $ 120,000

 

2. (a) Calculate the break-even point for the following firm:

Fixed costs $ 1,000,000, raw material costs per unit $10, direct labour $20 per unit and selling price $50.  The alternative wage available to the entrepreneur is $ 50,000 per year.

The break even point (including opportunity costs) = 1,050,000 / 20 =  52,500 units.   

(b) What is the level of profit made at the following output levels - 50,000 units, 60,000 units, 70,000 units, 80,000 units.

50,000 units = ($ 50,000)

60,000 units = $ 150,000

70,000 units = $ 350,000

80,000 units = $ 550,000

Activity 3

End this lesson by enjoying the following video about the world's most successful business man John Rockerfeller

Accompanying question:

How did John Rockerfeller build the world's most successful business and would this be possible now.  Consider the part of the video on monopoly legislation when answering this, regulations that were not in place when Rockerfeller started his business.