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“Is a lecture from open tuition to benefit from the lecture. You should download the the free lecture notes from open tuition comm semi variable costs and we spoke about variable costs way back in one of the early lectures second or third one. And it s looking at costs. Which are part variable and part fixed and our job is to split out what is the variable cost per unit.
And what is the fixed cost per period. And there to look at two methods in this chapter. While we did look at before which is the high low method so in a minute. I will revise that and then another method.
Which is perhaps somewhat better explain why when we come to it there s something called regression analysis. So as usual. I will split this chapter into two or three lectures. But first of all let s revise a high load method now again this shibir addition.
But look at example 1. And let s work through it electricity costs for the first six months of the year are as follows as we got six months there january through june and each month. We ve recorded how many units were produced and what the total cost was and you can see immediately that firstly. It s not a fixed cost that cost changes each time when there s february had fewer units than january.
So the cost was lower in march. More units the cost was higher now we can also see almost immediately that the cost is a truly variable you see if it was truly variable that cost per unit each month would stay the same and it isn t you see if you look at january 264. 340 units 260..
340. If it were truly variable. The costs would be 665 units. And it will be the same each month.
But if you re looking february. The cost is to 160. There are 300 units that will excel at 720. A unit and for the point is it it s obviously not a fixed cost.
But equally. It s not a completely variable cost. It s a combination of the two and our job is to calculate what s the variable cost per unit. And what s the fixed cost per month and we high low.
We take the highest and the lowest observations of what we call excuse me of what we call the independent variable. Now what i mean by that if surely here the cost will depend on the number of units cost depends on units. So cost is the dependent variable eunice is the independent variable well we take the highest and lowest of the observations of the independent variable. Which here is the units.
So what s the highest number of units. The highest number of units is in april. It s 420 units and the total cost in april was 2400 well we then take the lowest of the independent variable the lowest one is 300 which was in february and the so stated cost was to 160..
So do be careful is the highest and the lowest of this independent variable which isn t necessarily the highest and the lowest of the dependent variable of the cost and then we carry on exactly as we did in that earlier lecture in that we say wisely cost difference for those two months. And he thinks cost will be the same so the only reason the higher one is higher cost of the lower one is because of the extra variable costs of the extra units we look at the difference there were a hundred and twenty more units and the cost was higher by the difference of two hundred and forty well that 240 has to be the extra variable cost of those extra units and so he can say straight away the variable cost two forty four hundred and twenty units is 2 per unit. So a variable cost per unit. What about the fixed cost will go to either of those two high low.
If i go to life only one we know that the total cost is two thousand four hundred we now know how much of that is the total variable cost included in the two thousand four hundred must be a variable cost of four and twenty units at two dollars each. Which is 840 well if 840 of the total is the variable cost. The remainder must be the fixed cost the fixed cost must be zero six five fifteen hundred and sixty per month. Now.
I said when we did this before in the exam speed is of the essence and so be confident in yourself. However i am sorry my throat. We can check it easily enough if we look at the lower one oops. The lower there are 300 units.
So the variable cost is 300 at two dollars. A unit is 600 the fixed cost per month. We worked out of 1560 and so that would give a total cost of two 160 and does it work yes. It does the low was to 160.
But as i said a minute ago don t waste time checking in the exam to be confident. We ve got the variable. We ve got the fixed and although it doesn t answer it here we could write down a little equation could we not therefore any month..
The total cost will be equal to 1560 the fixed cost plus than two dollars per unit. So 2 times the number of units. That is the variable cost no problem ok so it s a nice easy approach. However there are problems with it in that firstly we ve only to the extremes.
Which could make it distorted. I miss by what i mean you see if we drew a little graph showing the total cost against the number of units in a perfect world. We d have a line like this if you remember we ve always got the fixed cost and in addition. The variable cost now again in a perfect world.
Everything would line perfectly on a line in fact in the real world. Although you would expect it to be more or less linear in the real world. Things aren t perfect. They may be a bit higher than their bit lower something like that and all we ve done is taken the lowest and the highest and you see they could be unusually high or unusually low.
But we ve effectively found a line like this joining the lowest with the highest now of course and i put them all on a graph like that to draw them aligned that most nearly goes through all of them well. It s not going to be the same all we ve done is take the top and the bottom and i say again it could be distorted. If things are working perfectly and everything lay exactly on the line. No problem.
But in the real world. It s not going to be precisely linear. So that s one problem..
Another problem is that we assumed. It s basically living up it could be if i did put them on a graph it could be that in fact it looks something like this a curve and yet we just hit the highest and the lowest join them up we ve assumed it s linear. And it may not be a third problem. It s even assuming.
It s linear. We can only really use it for forecasting within the range you see just because it s basically linear here. Doesn t mean that in the future. It makes us go like that or something.
And so it s dangerous to forecast outside the range again it may be reasonably linear. So if we tried to forecast for somewhere between what was it now 300 and for 20 units. Maybe will give us a reasonably good approximation. But we certainly couldn t say ah if it was a thousand units.
It s still going to be two dollars a unit variable plus fixed cost of fifteen sixty other things could affect it and so it s a nice simple quick easy approach. But at best. It is very approximate which is why there s potentially a much better approach which we ll look at in the next next lecture called regression. But i ll keep that separate make sure you are happy with milo you re certainly gonna get one or two milo questions and this should be easy marks.
Regression and you ll see is a little bit more ” ..
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