Break-even price

The break-even price is the price necessary to make normal profit. It is a price which includes all costs, including variable and fixed costs.

  • At the break-even price, the firm neither makes a loss or profit.
  • The break-even price occurs where AR = ATC
  • The break-even price occurs where Total Revenue = Total Cost (TC)

break-even-point-tr-tc

Formula for break-even price

break-even-price

(Total fixed cost / production unit volume) + variable cost per unit

Example of break-even price calculation

  • Fixed costs = £12,000
  • Average variable cost = £12
  • Output = 3,000
  • Break-even price = (12,000/3,000) + £12 = £16

Example 2

  • If the output increases to 24,000, the break-even price would be lower.
  • The average fixed cost would now be 12,000/24,000) = £0.50
  • Therefore, the break-even price would be £12.50

 

Diagram of break-even price

break-even-shut-down-price

At P2 – average revenue (AR) = ATC.

Break-even output

Suppose:

  • Fixed costs = £40,000
  • Average variable cost = £8
  • Market Price = £13

How much does the firm need to sell in order to break even, with a market price of £13?

break-even-quantity

Q = 40,000/ (13-8)

Q = 8,000

Uses of break-even price

  • A firm will be interested to know the break-even price. For example, if it is entering a market, it may be interested in the lowest price it can set without making a loss.
  • This is important for a firm with the objective of sales maximisation. One definition of sales maximisation is setting the price as low as possible, whilst still making normal profit (and breaking even).
  • A firm may find out its break-even price and then add a certain profit margin, to help set prices.

Evaluation of break-even price

  • A firm may not be able to easily calculate all its average total costs, and so in the real world, it could get the price wrong.
  • Similarly, it may calculate break-even price on a certain output, but if demand is less than expected, the price will be too low.

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