10b11pd311 economics cost theory and estimation. 10b11pd311 economics cost of production: costs...
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10B11PD311 Economics
Cost Theory and Estimation
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10B11PD311 Economics
Cost of Production: Costs incurred on factor inputs
Explicit Costs:Actual money spent in purchasing or hiring
services of factor inputsAccounting Costs
Economic Costs: Implicit Costs: Cost of self-owned and self-
employed resourcesAlternative or Opportunity Costs: value of an
input in its next best alternative use
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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: depreciationEconomic approach: change in the market value
from the beginning to the end of the period
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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
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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
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10B11PD311 Economics
Average Variable Cost
AVC = TVC = w L
Q Q
= w = w
Q/L APL
Marginal Cost
TC/Q = TVC/Q = (w L)/Q
= w = w
Q/L MPL
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10B11PD311 Economics
Q TFC TVC
0 $60 $0
1 60 20
2 60 30
3 60 45
4 60 80
5 60 135
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10B11PD311 Economics
Q TFC TVC TC AFC AVC ATC MC
0 $60 $0 $60 - - - -
1 60 20 80 $60 $20 $80 $20
2 60 30 90 30 15 45 10
3 60 45 105 20 15 35 15
4 60 80 140 15 20 35 35
5 60 135 195 12 27 39 55
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10B11PD311 Economics
0
50
100
150
200
250
0 1 2 3 4 5 6Output
Output
Cost
Cost
Total Cost Function
Per Unit Cost Function
0
10
20
30
40
50
60
70
80
90
0 1 2 3 4 5 6
T C
A V C
A C
M C
T F C
T V C
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10B11PD311 Economics
Long-Run Total Cost = LTC = f(Q)
Long-Run Average Cost = LAC = LTC/Q
Long-Run Marginal Cost = LMC = LTC/Q
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10B11PD311 EconomicsDerivation of Long-Run Cost Curves
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10B11PD311 Economics
Relationship Between Long-Run and Short-Run Average Cost Curves
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10B11PD311 Economics
Possible Shapes of the LAC Curve
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10B11PD311 Economics
Economies of Scale(output grows proportionately faster than inputs)
Indivisibility
Specialization
EquipmentMaintenance
Due to large plant Due to large firm
Innovation
Funds raising
Quantity discounts
Management
Technological forces/Plant economies
Financial forces/Firm economies
ProductivitySales promotion
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10B11PD311 Economics
Diseconomies of Scale
Transportation cost
Imperfection inlabor market
Due to large plant Due to large firm
Coordination andcontrol
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10B11PD311 Economics
Utility of Learning Curves• To forecast needs of
– personnel– machinery– raw materials
• Scheduling production• Determining Selling price of product
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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
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10B11PD311 Economics
Total Revenue = TR = (P)(Q)
Total Cost = TC = TFC + (AVC)(Q)
Profit = TR –TCProfit = = PQ - [TFC + (AVC)(Q)]
Q = TFC +
P - (AVC)
Profit contribution = P- AVC
QBE = TFC
(P - AVC)
At Breakeven point,TR = TC = TR - TC = 0
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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
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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 Development 10000Manual preparation and typesetting 3000Advertising 10000
Distribution Costs/ unit.Blank Disk 2Loading Cost 0.5Postage and Handling 1.25Printing of manual 2.75
Price of one program with manual = $40a). 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.
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10B11PD311 Economics
a). Determine breakeven no. of programs and TR at this volume.
Qe = 23000/ (40-6.5) = 686.6 unitsTR at Qe = 40*686.6 = $27,464
b). If Profit target = $40,000, determine the unit and dollar volume of sales.
Q40000 = (23000+40000) / (40-6.50) = 1880.6 unitsTR = $75, 224
c). If price falls by 25%, determine the new breakeven unit and dollar volume.
Qe = 978.7 unitsTR = 30* 978.7 = $29,361
Q = TFC +
P - (AVC)
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10B11PD311 Economics
TC’ has a higher DOL than TC and therefore a higher QBE
High Operating leverage means:
•substituting fixed for variable costs.
•profits are becoming more sensitive to Q.
DOL: Degree of operating leverage
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10B11PD311 Economics
Foreign Sourcing of Inputs New International Economies of Scale
product developmentpurchasingproductiondemand managementorder fulfillment
Immigration of Skilled LaborBrain Drain
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10B11PD311 Economics
Core Competencies Outsourcing of Non-Core Tasks Learning Organization Efficiency and Flexibility Agility in Responding to Market
Forces Location Near Markets