Академический Документы
Профессиональный Документы
Культура Документы
Topics to be Discussed
Measuring Cost: Which Costs Matter? How do Cost Curves Behave? Cost in the Short Run Cost in the Long Run How to Minimize Cost? How to draw Implications for Business Strategy?
Topics to be Discussed
Production with Two Outputs: Economies of Scope Dynamic Changes in Costs: The Learning Curve Estimating and Predicting Cost
Measuring Cost: Which Costs Matter? Accountants tend to take a retrospective view of firms costs, whereas economists tend to take a forward-looking view Accounting Cost Actual expenses plus depreciation charges for capital equipment Economic Cost Cost to a firm of utilizing economic resources in production, including opportunity cost
Implicit Costs: Costs that do not involve a direct money outlay (Ex. Opportunity costs of the owners own inputs used Implicit wages, implicit rent, cost of capital).
Opportunity Cost
Economic costs distinguish between costs the firm can control and those it cannot Opportunity cost
Cost associated with opportunities that are foregone when a firms resources are not put to their highest-value use
Opportunity cost of an action is the value of the next best alternative forgone. For an Input: What the input could have earned from best alternative use (outside the firm).
SUNK COST
Although opportunity costs are hidden and should be taken into account, sunk costs should not Sunk Cost EXPENDITURE THAT HAS BEEN MADE AND CANNOT BE RECOVERED Firm buys a piece of equipment that cannot be converted to another use
Sunk Cost
From a firms point of view it is the cost that arises when an investment in an asset can not be recovered by subsequent resale. Firm can neither sell nor lease it to any other person and even cannot be used for other alternative purposes. Investment is a SUNK COST when its OPPORTUNITY COST is zero.
Those costs that do not vary with the amount of output produced or level of output. Total obligations of the firm per given period (time) for all fixed inputs (Land, Building, Capital Equipment).
Exp: Payment for renting the plant and equipment if firm owns it, insurance, property taxes, salaries (for top management fixed by contract and to be paid during the period of contract irrespective of going for production or not) -Annual allowances made for depreciation (wear and tear) and expenditure on maintenance
Variable Cost
Those costs that do vary with the amount of output produced.
Obligations of the firm per period for all variable inputs
(Exp. Payment for Raw materials and fuels, expense on power and water supply, wages of labour)
Marginal Cost:
How much does it cost to produce an additional unit of output? Marginal Cost (MC): The extra or additional cost of producing one more unit of output.
MC =
TC
VC wL MC = = Q Q
TC
Cost 400
($ per year)
300
VC
200
Variable cost increases with production and the rate varies with increasing and decreasing returns.
100 50
0 1 2 3 4 5 6 7 8 9
FC
10 11 12 13 Output
Short Run Cost Curve: Summary Short run cost curves (AVC, ATC and MC) are UShaped- Law of variable proportion In the short run with fixed plant, there is a phase of INCREASING PRODUCTIVITY (falling unit costs) a phase of DECREASING PRODUCTIVITY (increasing unit cost) of the variable factors. Between these two phases there is a single point at which unit COSTS are MINIMUM. At this point on ATC, the plant is utilised optimally (optimal combinations of fixed and variable factors)
Cost Minimizing Input Choice in Long Run: Producing a Given Output at Minimum Cost
Capital per year
K2
Q1 is an isoquant for output Q1. There are three isocost lines, of which 2 are possible choices in which to produce Q1.
A K1 K3 C0 L2 L1 C1 L3
Isocost C2 shows quantity Q1 can be produced with combination K2,L2 or K3,L3. However, both of these are higher cost combinations than K1,L1.
Q1 C2
Labor per year
MPK
= w
MPK
Long Run versus Short Run Cost Curves The Inflexibility of Short Run Production
Capital E per year Capital is fixed at K1. To produce Q1, min cost at (K1,L1). If increase output to Q2, min. cost is K1 and L3 in short run. Long-Run Expansion Path In Long R, can change capital and min costs falls to K2 and L2.
Expansion Path: A Combination of Labour & Capital that firm chooses to K2 Minimize Cost at each Level of K1 Output.
Q2 Q1
L1 L2 B L3 D F Labor per year
Long Run Versus Short Run Cost Curves Long-Run Average Cost (LAC)
Most important determinant of the shape of the LR AC and MC curves is relationship between scale of the firms operation and inputs required to minimize cost
Long-Run Costs
How does per unit costs behave as the firm EXPANDS all INPUTS, even plant size or scale of operation? The Long-Run Average Total Cost (LRATC) reflects the lowest possible unit cost related to different plant sizes and/or scales of operation. In long run no fixed factor, all factors are variable.
LRATC=LVC or Average total and variable costs coincide.
In special case where LAC is constant, LAC and LMC are equal
LMC LAC
Output
Economies of Scale
Economies of Scale: Output can be doubled for less than a doubling Cost- Pindyck et al.
LRATC DECREASEs as the Scale of Operation INCREASES.
Diseconomies of Scale (DRS): Doubling of Output requires more than a doubling of Cost LRATC INCREASES with the scale of operation.
U-shaped LAC reflects ECONOMIES of SCALE for relatively low output levels and diseconomies of scale for higher levels
2. Scale can provide flexibility managers can organize production more effectively 3. DISCOUNT for BULK PURCHASE of INPUTS (Raw Materials)
Firm may be able to get inputs at lower cost if can get quantity discounts. Lower prices might lead to different input mix.
ECONOMIES of SCALE
-Change in TECHNOLOGY in the long run
Economies of Scale
Managerial Economies
Arises Primarily due to Specialisation of Management & Mechanisation of Managerial Function. Division of Managerial Task-Specialization of ManagementImprovement in Efficiency. High Degree of Mechanisation (Telephone, computer) and Decline in Cost Decision Making Process Decentralized (increase in efficiency)
Continues.
LOW COST OF FINANCE Larger firm can borrow at lower interest rate and have access to Financial Market Exp: PRIME LENDING RATE of Commercial Banks. Lower Salaries can be Paid if employees prefer to be associated with organisation of Repute or there is no LABOUR UNION (Low expenditureRelatively low cost)
Diseconomies of Scale
At some point, AC will begin to increase 1. FACTORY SPACE and MACHINERY may make it more difficult for workers to do their jobs efficiently 2.Managing a larger firm may become more complex and inefficient as the NUMBER OF TASKS INCREASES 3. Increase in INPUT PRICES resulting from increase in Usage by the firm or Limited availability of Inputs
C C EC =
Q Q
= MC
AC
Long Run Average Cost Curve: Flatbottomed (Rs) Curve (a Special Case)
Per Unit
LRATC Curve
Econ. of Scale Neither Economies nor Diseconomies of Scale Disecon . of Scale
Economies/Diseconomies of Scope: Case of Multi-Product Firm If Total Cost of jointly producing Cars and Trucks (T) is smaller than the cost incurred for producing cars and trucks independently by different firms ECONOMIES OF SCOPE Exists if TC(C,T) < [TC (C,0) + TC(0, T)] Reasons: Automobiles and Trucks can be produced with same metal sheet and engine assembly facilities. Joint Production: Better utilization of Production Facilities and lower costs.
Economies of Scope
Advantages 1.Both use capital and labor 2.The firms share management resources 3.Both use the same labor skills and types of machinery
Economies of Scale and Economies of Scope Economies of scale: Should a Public sector commercial bank merge with its competitor (other PSBs) Economies of Scope: Should Commercial Bank offer Mutual Fund or Life insurance scheme?
C(q1) is the cost of producing q1 C(q2) is the cost of producing q2 C(q1,q2) is the joint cost of producing both products
Dynamic Changes in Costs The Learning Curve Learning curve: Measures the impact workers experience on the costs of production Describes the RELATIONSHIP between a firms
CUMULATIVE output and the amount of INPUTS needed to produce each unit of output Learning curve information facilitates to take decision whether production operation is profitable or not. Based on the information plan how much cumulative output to be produced to reduce cost
10 8 6 4 2
0 10 20
Hours of Labour needed Per unit of output declines With increase in cumulative output
30
40
50
Economies of Scale
A B
Learning
AC1 AC2
Output
Sum up..
Relevance of studying cost of production Identify which cost matter How to minimize cost in the short run and long run Why is long run AC U-Shaped Distinction between Economies of Scale and Scope Role of Learning Curve in Cost