1. MANAGERIAL ECONOMICS 11th EditionBy
Mark Hirschey

2. Cost Analysis and Estimation
Chapter 9

3. Chapter 9 OVERVIEW What Makes Cost Analysis Difficult Opportunity Cost
Incremental and Sunk Costs in Decision Analysis
Short-run and Long-run Costs
Short-run Cost Curves
Long-run Cost Curves
Minimum Efficient Scale
Firm Size and Plant Size
Learning Curves
Economies of Scope
Cost-volume-profit Analysis

4. Chapter 9 KEY CONCEPTS historical cost current cost replacement cost
opportunity cost
explicit cost
implicit cost
incremental cost
profit contribution
sunk cost
cost function
short-run cost functions
long-run cost functions
short run
long run
planning curves
operating curves fixed cost
variable cost
short-run cost curve
long-run cost curve
economies of scale
cost elasticity
capacity
minimum efficient scale
multiplant economies of scale
multiplant diseconomies of scale
learning curve
economies of scope
cost-volume-profit analysis
breakeven quantity

5. What Makes Cost Analysis Difficult?
Link Between Accounting and Economic Valuations
Accounting and economic costs often differ.
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.

6. Opportunity Cost Opportunity Cost Concept Explicit and Implicit Costs
Opportunity cost is foregone value.
Reflects second-best use.
Explicit and Implicit Costs
Explicit costs are cash expenses.
Implicit costs are noncash expenses.

7. 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.
Sunk Cost
Irreversible expenses incurred previously.
Sunk costs are irrelevant to present decisions.

8. Short-run and Long-run Costs
How Is the Operating Period Defined?
At least one input is fixed in the short run.
All inputs are variable in the long run.
Fixed and Variable Costs
Fixed cost is a short-run concept.
All costs are variable in the long run.

9. 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.

12. Long-run Cost Curves Economies of Scale
Long-run cost curves show minimum cost in an ideal environment.

15. Cost Elasticity and Economies of Scale
Cost elasticity is εC = ∂C/C ÷ ∂Q/Q.
εC < 1 means falling AC, increasing returns.
εC = 1 means constant AC constant returns.
εC > 1 means rising AC, decreasing returns.

16. Long-run Average Costs

17. 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.

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

20. 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.

22. Economics of Multi-plant Operation: an Example
Plant Size and Flexibility

24. Learning Curves Learning Curve Concept Learning Curve Example
Learning causes an inward shift in the LRAC curve.
Learning curve advantages are often mistaken for economies of scale effects.
Learning Curve Example
Strategic Implications of the Learning Curve Concept
When learning results in 20% to 30% cost savings, it becomes a key part of competitive strategy.

26. Economies of Scope Economies of Scope Concept
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.

27. Cost-volume-profit Analysis
Cost-volume-profit Charts
Cost-volume-profit analysis shows effects of varying scale.
Breakeven analysis shows zero profit points of cost coverage.

29. Degree of Operating Leverage
DOL=Q(P-AVC)/[Q(P-AVC)-TFC]
DOL is the elasticity of profit with respect to output.