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10B11PD311 Economics Cost Theory and Estimation. 10B11PD311 Economics  Cost of Production:  Costs incurred on factor inputs  Explicit Costs:  Actual.

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Presentation on theme: "10B11PD311 Economics Cost Theory and Estimation. 10B11PD311 Economics  Cost of Production:  Costs incurred on factor inputs  Explicit Costs:  Actual."— Presentation transcript:

1 10B11PD311 Economics Cost Theory and Estimation

2 10B11PD311 Economics  Cost of Production:  Costs incurred on factor inputs  Explicit Costs:  Actual money spent in purchasing or hiring services of factor inputs  Accounting Costs  Economic Costs:  Implicit Costs: Cost of self-owned and self- employed resources  Alternative or Opportunity Costs: value of an input in its next best alternative use

3 10B11PD311 Economics  Fixed costs:  Costs which do not change with change in the quantity of output  Variable or Prime costs:  Costs which change with change in level of output  Cost of long-lived Assets during a period:  Traditional approach: depreciation  Economic approach: change in the market value from the beginning to the end of the period

4 10B11PD311 Economics  Sunk Costs:  Expenditures that have been made in the past or that must be made as part of a contractual agreement  Marginal cost:  Change in total cost associated with a one-unit change in output  Incremental Costs:  Total additional cost of implementing a managerial decision

5 10B11PD311 Economics Average Fixed Cost = AFC = TFC/Q Average Variable Cost = AVC =TVC/Q Average Total Cost = ATC = TC/Q Average Total Cost = AFC + AVC Marginal Cost = TC/Q = TVC/Q Total Cost = TC = f(Q) TC = TFC + TVC Total Fixed Cost = TFC & Total Variable Cost = TVC

6 10B11PD311 Economics Average Variable Cost AVC = TVC = w L Q Q = w Q/L AP L Marginal Cost TC/Q = TVC/Q = (w L)/Q = w Q/L MP L

7 10B11PD311 Economics QTFCTVC 0$60$0 16020 26030 36045 46080 560135

8 10B11PD311 Economics QTFCTVCTCAFCAVCATCMC 0$60$0$60---- 1602080$60$20$80$20 260309030154510 3604510520153515 46080140152035 56013519512273955

9 10B11PD311 Economics 0 50 100 150 200 250 0123456 Output Cost Total Cost Function Per Unit Cost Function 0 10 20 30 40 50 60 70 80 90 0123456 T C A V C A C M C T F C T V C

10 10B11PD311 Economics Long-Run Total Cost = LTC = f(Q) Long-Run Average Cost = LAC = LTC/Q Long-Run Marginal Cost = LMC = LTC/Q

11 10B11PD311 Economics Derivation of Long-Run Cost Curves

12 10B11PD311 Economics Relationship Between Long-Run and Short-Run Average Cost Curves

13 10B11PD311 Economics Possible Shapes of the LAC Curve

14 10B11PD311 Economics Economies of Scale (output grows proportionately faster than inputs) Indivisibility Specialization Equipment Maintenance Due to large plantDue to large firm Innovation Funds raising Quantity discounts Management Technological forces/ Plant economies Financial forces/ Firm economies Productivity Sales promotion

15 10B11PD311 Economics Diseconomies of Scale Transportatio n cost Imperfection in labor market Due to large plantDue to large firm Coordination and control

16 10B11PD311 Economics Utility of Learning Curves To forecast needs of –personnel –machinery –raw materials Scheduling production Determining Selling price of product

17 10B11PD311 Economics  Employee turnover  Production interruptions  Ability to transfer knowledge from other products  Average cost typically declines by 20-30% for each doubling of cumulative output for many firms

18 10B11PD311 Economics Total Revenue = TR = (P)(Q) Total Cost = TC = TFC + (AVC)(Q) Profit = TR –TC Profit =  = PQ - [TFC + (AVC)(Q)] Q = TFC +  P - (AVC) Profit contribution = P- AVC Q BE = TFC (P - AVC) At Breakeven point, TR = TC  = TR - TC = 0

19 10B11PD311 Economics P = 10 TFC = 200 AVC = 5 Shortcomings Assumes constant prices Assumes constant AVC Firm produces a single product or a constant product mix of products

20 10B11PD311 Economics MA Inc. specializes in the production and mail-order distribution of computer programs. The development and production costs (in $) are: Development Costs: Program Development10000 Manual preparation and typesetting 3000 Advertising10000 Distribution Costs/ unit. Blank Disk2 Loading Cost0.5 Postage and Handling1.25 Printing of manual2.75 Price of one program with manual = $40 a). Determine breakeven no. of programs and TR at this volume. b). If Profit target = $40,000, determine the unit and dollar volume of sales. c). If price falls by 25%, determine the new breakeven unit and dollar volume.

21 10B11PD311 Economics a). Determine breakeven no. of programs and TR at this volume. Qe = 23000/ (40-6.5) = 686.6 units TR at Qe = 40*686.6 = $27,464 b). If Profit target = $40,000, determine the unit and dollar volume of sales. Q 40000 = (23000+40000) / (40-6.50) = 1880.6 units TR = $75, 224 c). If price falls by 25%, determine the new breakeven unit and dollar volume. Qe = 978.7 units TR = 30* 978.7 = $29,361 Q = TFC +  P - (AVC)

22 10B11PD311 Economics TC’ has a higher DOL than TC and therefore a higher Q BE High Operating leverage means: substituting fixed for variable costs. profits are becoming more sensitive to Q. DOL: Degree of operating leverage

23 10B11PD311 Economics  Foreign Sourcing of Inputs  New International Economies of Scale  product development  purchasing  production  demand management  order fulfillment  Immigration of Skilled Labor  Brain Drain

24 10B11PD311 Economics  Core Competencies  Outsourcing of Non-Core Tasks  Learning Organization  Efficiency and Flexibility  Agility in Responding to Market Forces  Location Near Markets


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