Two of the most important figures for a business are the unit price and the total cost. In this lesson, we learn how to calculate both as well as the relationship between the two figures.
What’s a Unit Price?
As the head widget purchaser for your company, you are constantly immersed in a world of prices and quantities. However, you want more. In order to get promoted, you have to make sure that the next person to hold your current job is highly trained.
He is set to show up to your office on Monday morning, so you rest up and prepare yourself, ready to help this person make the most of the exciting world of widget purchasing.When Monday morning finally comes around, you’re a little disappointed. This person seems to know everything there is about using widgets. From gizmos to do-dads, it’s clear that he has a great appreciation for what your company buys. However, he really doesn’t get the nuts and bolts of how they are bought. Luckily, he has you.You sit him down and bring up a webpage showing the prices per widget at various manufacturers.
As you bring it up, he loudly interrupts you. Seeing the unit price next to the quantity, he thinks that widgets are actually much cheaper than they are! You stop him in his tracks, explaining that those prices next to the quantities are the unit prices, or the prices for each individual widget if they are bought in those quantities. You have to buy the widgets in the given quantities to get the given price for the widget.’But wait,’ he asks, ‘why does the price go down when you buy more?’ You then explain that there are two types of cost that go into producing each widget.
He looks at you puzzled. You explain that there are a variety of overhead costs, or costs unrelated to the production of each widget, associated with widget production. For example, you have to pay an accountant for bookkeeping, salespeople to work with clients, and janitors to keep everything clean. These costs don’t go away if you sell only 10 widgets, and unless you undertake some really massive expansions, they stay the same no matter how many widgets you sell.
Overhead Costs vs.
However, janitors, accountants, and salespeople alone do not produce widgets, nor do the costs associated with them make them. So, there are also production costs, which are those costs that are directly associated with making a widget. The raw materials, the electricity used to power the machines, even the wages of the workers – all of those are production costs.
They change depending on how many widgets you make. When you add the total production costs with the total overhead costs, you get the total cost.
You think you see a light bulb go on over your trainee’s head, but those hopes are quickly extinguished. ‘So the more we spend, the more money we save?’ he offers. You recline in your chair and respond, ‘Well, sort of.’ Sure, you get them at a slight discount if you purchase more, but the point is that you always have to spend more money to get more widgets. The per unit price of widgets when you purchase 10,000 of them will certainly be lower than the per unit price of just buying 100 widgets.
However, you still end up paying a lot more for those 10,000 widgets than you would for just 100. To get the unit cost from the total cost, just divide the total cost by the total number of units purchased. Meanwhile, to get the total cost from the unit cost, multiply the units purchased by the unit cost.You notice that he’s eyeing his watch. ‘Hungry?’ you ask. He confirms, and you see your opening. You explain that it’s just like a fast food place offering a meal or combo deal on its food.
It encourages you to buy more because at some level the food is cheaper when bought all at once rather than buying each thing separately. Much better for you to just buy everything at once and get a little discount to speed things up.
In this lesson, we took a look at the concepts of unit price and total cost, especially in how that unit prices can be made to be lower as you buy more products. We saw that it was as a result of overhead costs, which don’t change with respect to how much that a business sells. In the end, we compared the two concepts to the idea of getting a fast food combo meal.