8/8/2019 ME11--Ch. 9

1/32

MANAGERIALMANAGERIAL

ECONOMICS 11ECONOMICS 11thth EditionEdition

ByBy

Mark HirscheyMark Hirschey

8/8/2019 ME11--Ch. 9

2/32

Cost Analysis andCost Analysis and

EstimationEstimationChapter 9Chapter 9

8/8/2019 ME11--Ch. 9

3/32

Chapter 9Chapter 9OVERVIEWOVERVIEW What Makes Cost Analysis Difficult

Opportunity Cost

Incremental and Sunk Costs in Decision Analysis Short-run and Long-run Costs

Short-run CostCurves

Long-run CostCurves

Minimum Efficient Scale Firm Size and Plant Size

Learning Curves

Economies of Scope

Cost-volume-profit Analysis

8/8/2019 ME11--Ch. 9

4/32

Chapter 9Chapter 9

KEY CONCEPTSKEY 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

8/8/2019 ME11--Ch. 9

5/32

What Makes Cost Analysis

Difficult? Link Between Accounting and EconomicValuationsAccounting and economic costs often differ.

Historical Versus CurrentCosts Historical cost is the actual cash outlay. Current cost is the present costof previously

acquired items.

ReplacementCost Costof replacing productive capacity using

current technology.

8/8/2019 ME11--Ch. 9

6/32

Opportunity Cost

Opportunity CostConcept

Opportunity cost is foregone value.

Reflects second-best use.

Explicit and ImplicitCosts

Explicit costs are cash expenses.

Implicit costs are noncash expenses.

8/8/2019 ME11--Ch. 9

7/32

Incremental and Sunk Costs in

Decision Analysis Incremental Cost

Incremental cost is the change in cost tied toa managerial decision.

Incremental cost can involve multiple units ofoutput.

Marginal cost involves a single unitofoutput.

Sunk Cost Irreversible expenses incurred previously.

Sunk costs are irrelevant to present decisions.

8/8/2019 ME11--Ch. 9

8/32

Short-run and Long-run Costs

How Is the Operating Period Defined?

At leastone 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.

8/8/2019 ME11--Ch. 9

9/32

Short-run Cost Curves

Short-run CostCategories

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 minimumcost in a given production environment.

8/8/2019 ME11--Ch. 9

10/32

8/8/2019 ME11--Ch. 9

11/32

8/8/2019 ME11--Ch. 9

12/32

Long-run Cost Curves

Economies of Scale

Long-run cost curves show minimum

cost in an ideal environment.

8/8/2019 ME11--Ch. 9

13/32

8/8/2019 ME11--Ch. 9

14/32

8/8/2019 ME11--Ch. 9

15/32

Cost Elasticity and Economies

of Scale Cost elasticity is C = C/C Q/Q.

C< 1 means falling AC, increasing

returns. C= 1 means constant AC constant

returns.

C > 1 means rising AC, decreasingreturns.

8/8/2019 ME11--Ch. 9

16/32

Long-run Average Costs

8/8/2019 ME11--Ch. 9

17/32

Minimum Efficient Scale

Competitive Implications of MinimumEfficient Scale

MES is the minimum pointon 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 ismodest.

8/8/2019 ME11--Ch. 9

18/32

Transportation Costs and MES

Terminal, line-haul and inventory costs can beimportant.

High transport costs reduce MES impact.

8/8/2019 ME11--Ch. 9

19/32

8/8/2019 ME11--Ch. 9

20/32

Firm Size and Plant Size

Multi-plant Economies and Diseconomiesof Scale

Multi-plant economies are c

ost advantagesfrom operating several plants.

Multi-plant diseconomies are costdisadvantages from operating several plants.

8/8/2019 ME11--Ch. 9

21/32

8/8/2019 ME11--Ch. 9

22/32

Economics of Multi-plant

Operation: an Example

Plant Size and Flexibility

8/8/2019 ME11--Ch. 9

23/32

8/8/2019 ME11--Ch. 9

24/32

Learning Curves

Learning Curve Concept Learning causes an inward shift in the LRAC

curve.

Learning curve advantages are often mistakenfor 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 partof competitivestrategy.

8/8/2019 ME11--Ch. 9

25/32

8/8/2019 ME11--Ch. 9

26/32

Economies of Scope

Economies of Scope Concept

Scope economies are cost advantages thatstem from producing multiple outputs.

Big scope economies explain the popularity ofmulti-product firms.

Without scope economies, firms specialize.

Exploiting Scope Economies Scope economics often shape competitive

strategy for new products.

8/8/2019 ME11--Ch. 9

27/32

Cost-volume-profit Analysis

Cost-volume-profitCharts

Cost-volume-profit analysis shows effects ofvarying scale.

Breakeven analysis shows zero profit points ofcost coverage.

8/8/2019 ME11--Ch. 9

28/32

8/8/2019 ME11--Ch. 9

29/32

Degree of Operating Leverage

DOL=Q(P-AVC)/[Q(P-AVC)-TFC]

DOL is the elasticity of profit with respect tooutput.

8/8/2019 ME11--Ch. 9

30/32

8/8/2019 ME11--Ch. 9

31/32

8/8/2019 ME11--Ch. 9

32/32