Managerial Economics in a Global EconomyChapter 7Cost Theory and Estimation
The Nature of CostsExplicit CostsAccounting CostsEconomic CostsImplicit CostsAlternative or Opportunity CostsRelevant CostsIncremental CostsSunk Costs are Irrelevant
Short-Run Cost FunctionsTotal Cost = TC = f(Q)Total Fixed Cost = TFCTotal Variable Cost = TVCTC = TFC + TVC
Short-Run Cost FunctionsAverage Total Cost = ATC = TC/QAverage Fixed Cost = AFC = TFC/QAverage Variable Cost = AVC = TVC/QATC = AFC + AVCMarginal Cost = TC/Q = TVC/Q
Short-Run Cost FunctionsQTFCTVCTCAFCAVCATCMC0$60$0 $60----16020 80$60$20$80$202603090301545103604510520153515460801401520353556013519512273955
TFC
Short-Run Cost FunctionsAverage Variable CostAVC = TVC/Q = w/APL
Marginal CostTC/Q = TVC/Q = w/MPL
Long-Run Cost CurvesLong-Run Total Cost = LTC = f(Q)Long-Run Average Cost = LAC = LTC/QLong-Run Marginal Cost = LMC = LTC/Q
Derivation of Long-Run Cost Curves
Relationship Between Long-Run and Short-Run Average Cost Curves
Possible Shapes of the LAC Curve
Learning CurvesAverage Cost of Unit Q = C = aQbEstimation Form: log C = log a + b Log Q
Minimizing Costs InternationallyForeign Sourcing of InputsNew International Economies of ScaleImmigration of Skilled LaborBrain Drain
Architecture of Ideal FirmCore CompetenciesOutsourcing of Non-Core TasksLearning OrganizationEfficiency and FlexibilityLocation Near MarketsAgility in Responding to Market Forces
Cost-Volume-Profit AnalysisTotal Revenue = TR = (P)(Q)Total Cost = TC = TFC + (AVC)(Q)Breakeven Volume TR = TC(P)(Q) = TFC + (AVC)(Q)QBE = TFC/(P - AVC)
Cost-Volume-Profit AnalysisP = 10TFC = 200AVC = 5QBE = 40
Operating LeverageOperating Leverage = TFC/TVCDegree of Operating Leverage = DOL
Operating LeverageTC has a higher DOL than TC and therefore a higher QBE
Empirical EstimationData Collection IssuesOpportunity Costs Must be Extracted from Accounting Cost DataCosts Must be Apportioned Among ProductsCosts Must be Matched to Output Over TimeCosts Must be Corrected for Inflation
Empirical EstimationFunctional Form for Short-Run Cost FunctionsTheoretical FormLinear Approximation
Empirical EstimationTheoretical FormLinear Approximation
Empirical EstimationLong-Run Cost Curves
Cross-Sectional Regression AnalysisEngineering MethodSurvival Technique
Empirical EstimationActual LAC versus empirically estimated LAC