Final answer:
Break-even analysis attempts to address questions regarding revenue needed to cover costs, units to be sold to reach break-even, and break-even sales volume in dollars. It does so by comparing total revenue with total costs and using the average cost curve to identify profits or losses. The shutdown point and the price for continued short-run production are determined with respect to average cost and variable costs.
Step-by-step explanation:
Break-even analysis attempts to address several critical questions regarding a company's financials and operations. Specifically, the analysis looks to answer: How much revenue is needed to cover all costs? How many units need to be sold to reach the break-even point? What is the breakeven sales volume in dollars? While the profit margin for each unit sold is related to cost management, it is not directly addressed by break-even analysis. The exercises related to the WipeOut Ski Company dive deeper into these concepts.
The concepts helping us calculate profits include understanding that total revenue is the product of the price per unit and the number of units sold. To identify profits and losses with the average cost curve, compare the average cost per unit to the selling price per unit. If the selling price is higher, the firm is making a profit. If the selling price is lower, the firm is incurring a loss.
When determining the shutdown point, a firm should look at the average variable cost. If the price at which they can sell the product is less than the average variable cost, the firm would minimize their losses by shutting down production. Conversely, if the price covers at least the average variable costs, the firm should continue producing in the short run even if they are not covering total costs because they are contributing to fixed costs and minimizing losses.
For the WipeOut Ski Company, if they are producing and selling 5 units at $25 each, the total revenue can be calculated as 5 units × $25/unit = $125. The company's profits or losses would then be determined by comparing this total revenue to the total costs. If the average cost per unit is less than $25, the company is making a profit; if it is greater, the company is at a loss. If the marginal cost of the fifth unit is less than $25, then the marginal unit is adding to profits.