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PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Managerial Economics in a Global Economy Chapter 7 Cost.

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Presentation on theme: "PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Managerial Economics in a Global Economy Chapter 7 Cost."— Presentation transcript:

1 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Managerial Economics in a Global Economy Chapter 7 Cost Theory and Estimation

2 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. The Nature of Costs Explicit Costs –Accounting Costs Economic Costs –Implicit Costs –Alternative or Opportunity Costs Relevant Costs –Incremental Costs –Sunk Costs are Irrelevant

3 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Short-Run Cost Functions Total Cost = TC = f(Q) Total Fixed Cost = TFC Total Variable Cost = TVC TC = TFC + TVC

4 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Short-Run Cost Functions Average Total Cost = ATC = TC/Q Average Fixed Cost = AFC = TFC/Q Average Variable Cost = AVC = TVC/Q ATC = AFC + AVC Marginal Cost =  TC/  Q =  TVC/  Q

5 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Short-Run Cost Functions

6 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved.

7 Short-Run Cost Functions Average Variable Cost AVC = TVC/Q = w/AP L Marginal Cost  TC/  Q =  TVC/  Q = w/MP L

8 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Long-Run Cost Curves Long-Run Total Cost = LTC = f(Q) Long-Run Average Cost = LAC = LTC/Q Long-Run Marginal Cost = LMC =  LTC/  Q

9 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Derivation of Long-Run Cost Curves

10 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Relationship Between Long-Run and Short-Run Average Cost Curves

11 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Possible Shapes of the LAC Curve

12 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Learning Curves Average Cost of Unit Q = C = aQ b Estimation Form: log C = log a + b Log Q

13 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Minimizing Costs Internationally Foreign Sourcing of Inputs New International Economies of Scale Immigration of Skilled Labor Brain Drain

14 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Architecture of Ideal Firm Core Competencies Outsourcing of Non-Core Tasks Learning Organization Efficiency and Flexibility Location Near Markets Agility in Responding to Market Forces

15 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Cost-Volume-Profit Analysis Total Revenue = TR = (P)(Q) Total Cost = TC = TFC + (AVC)(Q) Breakeven Volume TR = TC (P)(Q) = TFC + (AVC)(Q) Q BE = TFC/(P - AVC)

16 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Cost-Volume-Profit Analysis P = 40 TFC = 200 AVC = 5 Q BE = 40

17 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Operating Leverage Operating Leverage = TFC/TVC Degree of Operating Leverage = DOL

18 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Operating Leverage TC’ has a higher DOL than TC and therefore a higher Q BE

19 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Empirical Estimation Data Collection Issues Opportunity Costs Must be Extracted from Accounting Cost Data Costs Must be Apportioned Among Products Costs Must be Matched to Output Over Time Costs Must be Corrected for Inflation

20 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Empirical Estimation Functional Form for Short-Run Cost Functions Theoretical FormLinear Approximation

21 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Empirical Estimation Theoretical FormLinear Approximation

22 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Empirical Estimation Long-Run Cost Curves Cross-Sectional Regression Analysis Engineering Method Survival Technique

23 PowerPoint Slides by Robert F. BrookerCopyright (c) 2001 by Harcourt, Inc. All rights reserved. Empirical Estimation Actual LAC versus empirically estimated LAC’

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