Now I'm going to give you an opportunity to practice estimating cost functions using the high, low method. Let's return to the two examples that we used in the prior Your Turn segment on scatter plots. But this time, we will use the high, low method to estimate the cost functions. Here is the first example. We have a scatter plot of observations where costs are on the vertical or y-axis and the number of units are on the horizontal, or the x-axis. And remember with the high, low method, you'll need to first, pick a typical low activity observation and a typical high activity observation. Now it looks here, like there's several that we could pick that would be typical. I'm looking at low activity here, maybe this one or this one or this one or this one. They seem to be falling in that typical range, so that we're all working with the same observations. Let me suggest that we pick this one. 950,000 in costs and 10,000 in the number of units. As our typical low activity observation and we could pick a number of different ones for the high activity, as well. Let's just go with this one as our typical high activity level observation. 2,975,000 in costs and that's 55,000 units. So, we'll use that as our typical high activity observation. So that would be your first step, we've taken care of that. Second, you'll need to calculate variable costs using those two observations. Then third, you'll calculate fixed cost by subtracting variable cost from total cost using either of these two observations. And then fourth, you'll use that to write the equation and why. So, take a few minutes. Give it a try, then come back. We'll see how you did and I'll meet you at the Lightboard. Hello again, here we're back at the Lightboard. We're going to talk a little bit about the high, low method. How did it go for you? I suspect that you did pretty well, but we'll give it a try and see what happens. Now remember with the high, low method, the first thing we're going to do is take a typical low activity observation and a typical high activity observation. And we did that before I turned you lose for you to take your turn and we have decided on these low activity, and high activity observations as representative of typical observations. This was $950,000 in costs at an activity level of 10,000 units. And then our typical high activity level observation, we chose $2,975,000 in costs at an activity level of 55,000 units. So, that was the first step we completed that together before you took your turn. And then from there, you were off and running. So, let's see what happens next. The second step with the high, low method as you recall is now that we've picked our high and our low activity observations, we're going to calculate the variable cost per unit from those two observations. So we're going to take the high activity level cost, subtract from the low activity level cost and divide that by the difference in units. Let's do that. The typical high activity level costs $2,975,000. The typical low activity observation cost 950,000. We divide that by the respective units, the high activity level 55,000 units and the low activity level 10,000 units. And we see that we're at a variable cost of $45 per unit. So, that was our second step. Remember the first step, choosing the two observations. Second step, calculating the variable cost per unit. Then our third step is we're going to pick, either one of these two points. Either the high or the low activity, it doesn't matter. Each will work equally well and we're going to calculate our fixed cost at that particular activity level by taking the total cost of that level minus the variable cost of that level. What's left will be the fixed price. So, let's do the low activity level as our example. Our total costs at this point are $950,000. Of those 950,000, part are variable and part are fixed. The variable portion is $45 per unit times the number of units. Well, at this observation level, there's 10,000 units. So total cost of 950, variable cost of $450,000. So, that means what's left over is our fixed cost. $500,00 is our estimate of fixed cost. Now incidentally, if we had chosen the high activity level to do this calculation, we should see the same $500,00. Let's prove that. If we had taken $2,975,000 in total costs and subtracted the variable cost at this point, 45 per unit times 55,000 units. Then we would have, let's see. This is not 450,000, it's 2,475. 45 times 55,000, 2,475. So total cost at this point, 2,975. Our variable cost, 2,475. The difference, $500,000. Makes sense, doesn't it? Because the fixed cost should be the same at either of these activity levels. Feeling good, we're going to go to the last step. We're going to use all of this work. To write the equation of the line or the cost function. Our slope, variable cost per unit, 45 times the number of units plus our fixed cost of $500,000. Straightforward. Great job.
