MANAGERIAL ECONOMICS 11th Edition

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MANAGERIAL ECONOMICS 11th Edition

• By
• Mark Hirschey

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Cost Analysis and Estimation

• Chapter 9

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Chapter 9OVERVIEW

• What Makes Cost Analysis Difficult
• Opportunity Cost
• Incremental and Sunk Costs in Decision Analysis
• Short-run and Long-run Costs
• Firm Size and Plant Size
• Learning Curves
• Cost-volume-profit Analysis

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What Makes Cost Analysis Difficult?

• Cost analysis is made difficult by the effects of
  unforeseen inflation and unpredictable changes in
  technology.
• Link Between Accounting and Economic Valuations
• Accounting and economic costs often differ.

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• Historical Versus Current Costs
• Historical cost is the actual cash outlay.
• Current cost is the present cost of previously
  acquired items.
• Replacement Cost
• Cost of replacing productive capacity using
  current technology.

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Opportunity Cost

• Opportunity Cost Concept The cost of using
  resources to produce a good or service is the
  opportunity cost to the owners of the firm using
  those resources. The opportunity cost to the
  firms owners of using a resource is what the
  owners must give up to use the resource. All
  costs of production are opportunity costs, and
  for decision making purposes, it is opportunity
  costs that matter.
• The foregone value associated with the current
  rather than next-best use of a given asset
• The opportunity cost of using an input or a
  resource is classified as either an explicit or
  an implicit cost.

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• Explicit and Implicit Costs
• Explicit cost An out-pocket monetary (cash)
  payment for the use of a resource.
• Implicit cost The forgone return the firms
  owners could have received had they used their
  own resources in their best alternative
  (noncash).

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Incremental and Sunk Costs in Decision Analysis

• Incremental Cost
• Incremental cost is the change in cost tied to a
  managerial decision.
• Incremental cost can involve multiple units of
  output.
• Marginal cost involves a single unit of output.
• Profit Contribution P - AVC
• Sunk Cost
• Irreversible expenses incurred previously.
• Sunk costs are irrelevant to present decisions.

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Short-run and Long-run Costs

• Short-run cost functions, used for day-to-day
  operating decisions.
• Long-run cost functions, used for long-range
  planning.
• How Is the Operating Period Defined?
• At least one input is fixed in the short run.
• All inputs are variable in the long run.

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• Fixed and Variable Costs
• Fixed cost is a short-run concept.
• All costs are variable in the long run.

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Short-run Cost Curves

• Short-run Cost Categories
• Total Cost Fixed Cost Variable Cost
• For averages, ATC AFC AVC
• Marginal Cost, MC ?TC/?Q
• Short-run Cost Relations
• Short-run cost curves show minimum cost in a
  given production environment.

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Long-run Cost Curves

• Long-run cost curves show minimum cost in an
  ideal environment
• Economies of Scale Occur when long-run average
  cost falls as output increases.

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Cost Elasticity and Economies of Scale

• Cost elasticity, measures the change in TC
  associated with a 1 in output.
• Cost elasticity is eC ?C/C ?Q/Q.
• eC lt 1 means falling AC, increasing returns.
• eC 1 means constant AC constant returns.
• eC gt 1 means rising AC, decreasing returns.

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Minimum Efficient Scale

• Competitive Implications of Minimum Efficient
  Scale
• MES is the minimum point on the LRAC curve.
• Competition is most vigorous when
• MES is small in absolute terms.
• MES is a small share of industry output.
• Disadvantage to less than MES scale is modest.

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Transportation Costs and MES

• Terminal, line-haul and inventory costs can be
  important.
• High transport costs reduce MES impact.

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Firm Size and Plant Size

• Multi-plant Economies and Diseconomies of Scale
• Multi-plant economies are cost advantages from
  operating several plants.
• Multi-plant diseconomies are cost disadvantages
  from operating several plants.

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Learning Curves

• Learning Curve Concept
• For many manufacturing processes, average costs
  decline substantially as cumulative total output
  increases. Advantages to learning are present
  when AC fall with greater production experience.
• Learning causes an inward shift in the LRAC
  curve.
• Learning curve advantages are often mistaken for
  economies of scale effects.

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• Learning Rate,is defined as the percentage by
  which average cost falls as output doubles.
• LR
• Strategic Implications of the Learning Curve
  Concept
• When learning results in 20 to 30 cost savings,
  it becomes a key part of competitive strategy.

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Economies of Scope

• Economies of Scope exist when the joint cost of
  producing two or more goods is less that the sum
  of the separate costs of producing the goods.
• Scope economies are cost advantages that stem
  from producing multiple outputs.
• Big scope economies explain the popularity of
  multi-product firms.
• Without scope economies, firms specialize.
• Exploiting Scope Economies
• Scope economics often shape competitive strategy
  for new products.

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Cost-volume-profit Analysis

• Cost-volume-profit Charts
• Cost-volume-profit analysis Analytical technique
  used to study relations among costs, revenues,
  and profits.
• Breakeven analysis shows zero profit points of
  cost coverage.
• Profit Contribution P - AVC

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Degree of Operating Leverage

• DOLPercentage Change in Profit / Percentage
  Change in Sales
• DOL(??/?)/(?Q/Q)
• DOL (??/?Q)?(Q/?)
• DOLQ(P-AVC)/Q(P-AVC)-TFC
• DOL is the elasticity of profit with respect to
  output.

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Self Test Problem 1
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Self Test Problem 2
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