The Contribution Margin
Price – AVC in the above equation represents the contribution margin. Thus the above equation can be written as
Point = TFC
The below diagram
explains the contribution margin where TVC is the total variable cost. TFC (total fixed
cost) is added to TVC in order to arrive at TC (Total Cost). The difference between
TR and TVC is the contribution margin.
Let us assume the following:
- Total Fixed Cost as $300
- Average Variable Cost as $24 and
- Price P as $30
Now with these values, compute the BE Quantity
BE Quantity = 300
30 – 24
= 300 =
Now, TR = P x Q
= 30 x 50
TR = $1500
TC = TFC + TVC = 300 + (24 x 50) = $ 1500
Thus BE point is 50 units where TR ($1500) = TC ($1500)
- The cost and revenue functions are linear
- Total cost is divided into fixed and variable costs
- Fixed cost is constant
- Variable costs change proportionately with output
- The number of units produced and sold of the product is identical. It means that there is no opening or closing stock
- The sale price is constant
- Factor prices are constant
- Costs are affected only by the quantity produced
- There is no change in technology and productivity
- There is only one product. In case of multi-products, the product mix remains constant
Limitations of Break Even Analysis
- Constant Price
The straight line TR curve assumes that every level of output can be sold at the same price. This is unrealistic for the reason that product prices do not remain constant as output hikes. In fact, they change frequently.
- Constant Cost
It is also assumed that whatever the level of output, AVC remains the same. This suggests that there is no limit to output which the firm can produce. This is again highly unrealistic.
- Limitless Profits
This analysis assumes that profits are a function of output. This suggests that profits increase without limit as the level of output rises. In fact this never happens for the reason profits are influenced by technological changes, improved management, higher productivity, changes in the scale of fixed factors etc.
- Ignores Selling Costs
It is based only on production costs and neglects selling costs.
- Data Limitations
As the BE analysis is based on accounting data, it suffers from such limitations of data as neglect of imputed costs, arbitrary depreciation estimates, inappropriate allocation of overhead costs etc.
- Limited Products
This analysis is based on a limited range of products and area. The present day firm produces many products and has many departments or plants which cannot be lumped together and presented on a single BE chart. So the scope of this analysis is limited to a single product of a particular business firm.
- Short run Analysis
The BEA can be used only during the short run. As such it is not an effective tool for the long run.
- Ignores Elasticity of Demand
It ignores the concept of elasticity of demand and the possibility that different prices may lead to different levels of demand. It also ignores the principle of diminishing returns which every firm has to keep in view for breaking even
Online Live Tutor Limitations of Break Even Analysis:
We have the best tutors in Economics in the industry. Our tutors can break down a complex Limitations of Break Even Analysis problem into its sub parts and explain to you in detail how each step is performed. This approach of breaking down a problem has been appreciated by majority of our students for learning Limitations of Break Even Analysis concepts. You will get one-to-one personalized attention through our online tutoring which will make learning fun and easy. Our tutors are highly qualified and hold advanced degrees. Please do send us a request for Limitations of Break Even Analysis tutoring and experience the quality yourself.
Online The Contribution Margin Help:
If you are stuck with an The Contribution Margin Homework problem and need help, we have excellent tutors who can provide you with Homework Help. Our tutors who provide The Contribution Margin help are highly qualified. Our tutors have many years of industry experience and have had years of experience providing The Contribution Margin Homework Help. Please do send us the The Contribution Margin problems on which you need help and we will forward then to our tutors for review.
- Break Even Analysis
- Concept of Factor Cost
- Criticism, Clark's Product Exhaustion Theorem
- Distributive Shares: The Product Exhaustion Theorem
- Inequality of Income, Effects of Inequality
- Interest, Gross and Pure Interest
- Investment Analysis and Social Cost Benefit
- Measurement of Inequality, Lorenz Curve
- Meaning of Minimum Wages, Benefits of Minimum Wages
- National Income Meaning and Measurement
- Net Present Value Method, Internal Rate of Return Method
- Price Level, Social Prestige, Conditions of Work
- Profit, Gross Profit and Net Profit
- Rent, Meaning of Economic Rent
- Time Preference Theory
- Theories of Distribution
- Theories of Profit, Rent Theory of Profit
- Value Added Approach to GNP
- Quasi Rent, Distinction Between Rent and Quasi Rent