PRODUCTION AND COSTS SAMPLE QUESTIONS ON SHORT-TERM COSTS AP Economics Mr. Bordelon.
10B11PD311 Economics Cost Theory and Estimation. 10B11PD311 Economics Cost of Production: Costs...
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Transcript of 10B11PD311 Economics Cost Theory and Estimation. 10B11PD311 Economics Cost of Production: Costs...
10B11PD311 Economics
Cost Theory and Estimation
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
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
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
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
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
10B11PD311 Economics
Q TFC TVC
0 $60 $0
1 60 20
2 60 30
3 60 45
4 60 80
5 60 135
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
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
10B11PD311 Economics
Long-Run Total Cost = LTC = f(Q)
Long-Run Average Cost = LAC = LTC/Q
Long-Run Marginal Cost = LMC = LTC/Q
10B11PD311 EconomicsDerivation of Long-Run Cost Curves
10B11PD311 Economics
Relationship Between Long-Run and Short-Run Average Cost Curves
10B11PD311 Economics
Possible Shapes of the LAC Curve
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
10B11PD311 Economics
Diseconomies of Scale
Transportation cost
Imperfection inlabor market
Due to large plant Due to large firm
Coordination andcontrol
10B11PD311 Economics
Utility of Learning Curves• To forecast needs of
– personnel– machinery– raw materials
• Scheduling production• Determining Selling price of product
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
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
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
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.
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)
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
10B11PD311 Economics
Foreign Sourcing of Inputs New International Economies of Scale
product developmentpurchasingproductiondemand managementorder fulfillment
Immigration of Skilled LaborBrain Drain
10B11PD311 Economics
Core Competencies Outsourcing of Non-Core Tasks Learning Organization Efficiency and Flexibility Agility in Responding to Market
Forces Location Near Markets