Managerial Econ the Breakeven Point

Managerial Econ

The breakeven point is calculated as follows (No author, 2013):

Fixed costs / (Price -- variable costs) = breakeven point

So in this example:

2160 / (66-48) = 120 units

Operating leverage is a measure of the firm's fixed costs relative to its variable costs. The higher the fixed costs, the higher the degree of operating leverage. A firm with a higher degree of operating leverage is more susceptible to changes in the demand conditions. A good example of an industry where companies have a high degree of operating leverage is the airline industry, which has high fixed costs associated with aircraft leases/ownership. With these high fixed costs, the companies in the industry are highly susceptible financially to changes in demand. Hotels are another such industry. A good example of an industry with low operating leverage is software, and those firms are much less susceptible to changes in demand conditions because they have low fixed costs.

The operating leverage for Tetrangle Manufacturing in this scenario, with q=170, is as follows:

OL = Q (P-VC) / Q (P-VC) -- FC

OL = 3060 / 900 = 3.4

This means that an increase in revenues of 1% should result in an increase in profit of 3.4%.

2. This is a complicated issue. On the surface, it makes more sense to lay off workers while retaining wages -- it is difficult to lower wages for all workers across the board unless there is a union with which such a proposal can be successfully negotiated. Workers tend to be a fixed cost, and a company facing permanently reduced demand should reduce its fixed costs, which probably means cutting the number of workers. However, a recession is not a permanent reduction in demand so the response has to be a bit more intelligent, knowing that eventually the business cycle will recover and the company will need to hire back workers when demand picks up again.

However, for some companies lowering the number of workers removes talent from the company that cannot easily be replaced when the economic situation improves. Some companies, like FedEx, prefer to avoid laying off permanent employees because the costs associated with hiring and training new employees are higher than if the hours of all existing permanent employees are reduced.