Final answer:
The break-even point is where total sales equal the sum of variable and fixed costs, leading to no profit or loss. This point is calculated by dividing fixed costs by the difference between sales per unit and variable cost per unit. Decisions on continued operations are based on whether variable costs are covered, influencing whether a firm minimizes its losses.
Step-by-step explanation:
At the break-even point, the equation that represents the relationship between sales, variable expenses, and fixed expenses is:
Break-Even Point (Units) = Fixed Costs / (Sales per Unit - Variable Cost per Unit)
This means that the sales at the break-even point equal the total of the variable and fixed costs, which is when profit is neither made nor lost. If a firm's sales are above this point, it will generate profit, whereas if they are below, it will incur losses. The key decision for a firm operating below the break-even point—whether to continue production or to shut down—depends on comparing its average variable cost to the market price. It is preferable to continue operations if the firm covers its variable costs and minimizes losses.
At zero production, only fixed costs exist, and as production increases, variable costs are added. The total cost curve includes these fixed costs as the vertical intercept. Average variable cost is calculated at each level of output and typically follows a U-shaped curve. A firm will earn profit before considering fixed costs if the average variable cost is lower than the market price.