4. A cost is relevant if it is
affected by a
management decision
• Opportunity cost
• Marginal cost
• Incremental cost
• Sunk cost http://article.wn.com/view/2014/06/24/Three_Graphs_that_Show_the
_Chinese_Mobile_Technology_Revolut/
7. Implicit Costs
• Value of the inputs owned
and used by the firm
• Economic costs
• Cost that does not require the
firm to give up money, but
rather opportunity
12. The sunk cost is an expense that
has already been incurred and
cannot be recovered
13. Nature of Costs
Incremental costs are associated with
a choice and therefore only ever
include forward-looking costs
sunk costs not included
Marginal costs refer to the cost to
produce one more unit of product or
service.
Marginal and Incremental
costs are used to help
management evaluate
different potential future
courses of action
20. 1 2 3 4 5
AFC -- $60 30 20 15 12
AVC -- $20 15 15 20 27
ATC -- $80 45 35 35 39
MC -- $20 10 15 35 55
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
AVC, ATC, and MC are
U-shaped
AFC continues to decline as
output increases
MC curve reaches its
minimum before intercepting
AVC and ATC curves at their
lowest points
21. Q1 Q2 Q3
(1) AVC first declines, reaches a minimum
at Q2, and rises thereafter
• AVC at its minimum, MC = AVC
(2) ATC first declines, reaches a minimum
at Q3, and rises thereafter
• ATC at its minimum, MC = ATC
(3) MC first declines, reaches a minimum at
Q1, and rises thereafter
• MC equals both AVC and ATC at
their minimum values
• MC lies below AVC and ATC over
the range for which these curves
decline, but lies above them when
they are rising
22. 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
AVC = TVC = wL = w = w
Q Q Q/L APL
AVC
TVC
Q
w
L
APL
– average variable cost
– total variable cost
– output level
– wage rate
– quantity of labor used
– average physical product of labor
26. LAC = LTC
Q
LMC = ΔLTC
ΔQ
• The U-shape of the LAC curve depends on
increasing, constant, and decreasing returns to
scale
• The relationship of the LMC-LTC is the same as the
short-run MC-ATC.
27. Relationship of Long-Run and
Short-Run Average Cost Curves
• Long-Run average cost curve shows
the minimum average cost of
producing any given level of output
• LAC curve is the tangent line to
each of the short-run average
curves
28. Returns to Scale
Constant returns to scale
Increasing returns to scale
Decreasing returns to scale
INPUT OUTPUT
INPUT OUTPUT
INPUT OUTPUT
29. Returns to Scale
Constant returns to scale
Increasing returns to scale
Decreasing returns to scale
INPUT OUTPUT
INPUT OUTPUT
INPUT OUTPUT
30.
31.
32.
33. Minimum Efficient
Scale (MES)
•The lowest output at
which minimum
average cost can be
achieved
•Important in determining
how many firms a
particular market can
support
34. Economies of
Scope
• The cost of
producing multiple
goods is less than
the aggregate cost
of producing each
item separately
• An important source
of economies of
scope is transferable
know-how
35. Learning Curves
• As firms gain experience in the
production of a commodity or
service, their average cost of
production usually declines
• from many experiences gained
• used to forecast needs for
personnel, machinery, raw
materials and for scheduling
production
38. Cost-Volume-Profit Analysis
(CVP Analysis / breakeven analysis)
Examines the relationship among total revenue, total
costs, and total profits of the firm at various levels of
output
TR = (P)(Q)
TC = TFC + (AVC)(Q)
TR=TC
41. QB = TFC .
P-AVC
Q
TFC = $200
P = $10
AVC = $5
Solve:
QB = $200 .
$10-$5
QB = 40
Contribution margin per unit
• Portion of the selling price
that can be applied to
cover fixed costs and
provide for profits
43. Operating Leverage (OL)
Refers to the ratio of the firms total fixed costs to total variable costs
Higher ratio = more leveraged
= profits are more sensitive to changes in output or sales
𝐷𝑂𝐿 =
%∆𝜋
%∆𝑄
=
∆𝜋/𝜋
∆𝑄/𝑄
=
∆𝜋
∆𝑄
.
𝑄
𝜋
DOL – degree of operating leverage
44. Q
FC = $200
FC’ = $300
AVC = $5
AVC’ = $3.33
QB’ = 45
TC’ has a higher DOL
than TC and therefore
a higher QB
45. 𝐷𝑂𝐿 =
60($10 − $5)
60 $10 − $5 − $200
=
$300
$100
= 3
Given:
Increase in output from 60 to 70 units
Find:
DOL with TC
46. 𝐷𝑂𝐿 =
60($10 − $5)
60 $10 − $5 − $200
=
$300
$100
= 3
𝐷𝑂𝐿′ =
60($10 − $3.33)
60 $10 − $3.33 − $300
≅
$400
$100
= 4
The degree of operating leverage (DOL)
increases as the firm becomes more
leveraged or capital intensive
47. New Economies of Scale
Minimizing costs internationally
International trade in inputs
Foreign sourcing of inputs - requirement to remain competitive
New international economies of scale
Firms must constantly explore sources of cheaper inputs and
overseas production
Product development, purchasing, production, demand
management, order fulfillment
Immigration of skilled labor
48. Logistics or supply-chain management
Merging at the corporate level of the purchasing, transportation,
warehousing, distribution and customer services functions rather than
dealing with them separately at division levels
Development of new and much faster algorithms that greatly facilitate the
solution of complex logistic problems
Growing use of just-in-time inventory management
Increasing trend toward globalization of production and distribution
50. Empirical Estimation
Data Collection Issues
Opportunity costs must be extracted from accounting cost data
Costs must be apportioned among products
Costs must be matched to output over time
Costs must be corrected for inflation
𝐶 = 𝑓(𝑄, 𝑋1, 𝑋2, … , 𝑋𝑛)
56. Architecture of Ideal Firm
Core Competencies
Outsourcing of Non-Core Tasks
Learning Organization
Efficiency and Flexibility
Location Near Markets
Agility in Responding to Market Forces
57. References
Salvatore, D. (2007). Managerial Economics In A Global Economy (Sixth ed.). New York: Oxford
University Press.
Samuelson, W. F., & Marks, S. G. (2010). Managerial Economics (Sixth ed.). New Jersey: John
Wiley & Sons, Inc.
Thomas, C. R., & Maurice, S. (2011). Managerial Economics Foundations of Business Analysis
and Strategy (Tenth ed.). New York: McGraw-Hill Co.
*Web site sources for other graphs
