Session 13 14 Cost Theory Estimation

Session 13 14 Cost Theory Estimation - Transcript

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Copyright 2007 by Oxford University Press Inc

Slide 1

1

The Nature of Costs
Explicit Costs
Accounting Costs

Economic Costs
Implicit Costs Alternative or Opportunity Costs

Relevant Costs
Incremental Costs Sunk Costs are Irrelevant
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Slide 2

Short Run Cost Functions
Total Cost TC f Q Total Fixed Cost TFC Total Variable Cost TVC TC TFC TVC

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Slide 3

Short Run Cost Functions
Average Total Cost ATC TC Q Average Fixed Cost AFC TFC Q Average Variable Cost AVC TVC Q ATC AFC AVC Marginal Cost TC Q TVC Q
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Slide 4

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Slide 5

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Slide 6

Short Run Cost Functions
Average Variable Cost AVC TVC Q w APL

Marginal Cost TC Q TVC Q w MPL
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Slide 7

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Slide 8

Long Run Cost Curves
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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Slide 9

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Slide 10

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Slide 11

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Slide 12

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Slide 13

Average Cost of Unit Q C aQb Estimation Form log C log a b Log Q

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Slide 14

Minimizing Costs Internationally
Foreign Sourcing of Inputs New International Economies of Scale Immigration of Skilled Labor Brain Drain

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Slide 15

Logistics or Supply Chain Management
Merges and integrates functions
Purchasing Transportation Warehousing Distribution Customer Services

Source of competitive advantage
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Slide 16

Logistics or Supply Chain Management
Reasons for the growth of logistics
Advances in computer technology
Decreased cost of logistical problem solving

Growth of just in time inventory management
Increased need to monitor and manage input and output flows

Globalization of production and distribution
Increased complexity of input and output flows
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Slide 17

Cost Volume Profit Analysis
Total Revenue TR P Q Total Cost TC TFC AVC Q Breakeven Volume TR TC P Q TFC AVC Q QBE TFC P AVC Breakeven Analysis can also be used in determining the target output QT at which a target profit T can be achieved QT TFC T P AVC
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Slide 18

P 10 TFC 200 AVC 5 QBE 40

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Slide 19

Operating Leverage
Operating Leverage TFC TVC
The higher the above ratio the more leveraged i e more automated or capital intensive which means substitute fixed for variable costs is said to be Because of the higher total fixed cost the breakeven output of the firm increases See next Slide

Degree of Operating Leverage DOL Q P AVC
DOL Q Q P AVC TFC
The numerator in the above equation is the total contribution to fixed costs and profits of all units sold by the firm and the denominator is the total economic profit
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Slide 20

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Slide 21

Opportunity Costs must be extracted from accounting cost data e g if the firm owns the building in which it operates inventories used in current production Costs must be correctly apportioned to the various products produced by the firm Costs must be matched to output over time i e allocate costs to the period in which the output is produced rather than to the period when the costs were incurred Costs must be corrected for inflation
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Empirical Estimation Data Collection Issues

Copyright 2007 by Oxford University Press Inc

Slide 22

Empirical Estimation
Functional Form for Short Run Cost Functions
Theoretical Form Linear Approximation

TVC aQ bQ 2 cQ 3 TVC 2 AVC a bQ cQ Q MC a 2bQ 3cQ 2
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TVC a bQ a AVC b Q
MC b
Copyright 2007 by Oxford University Press Inc
Slide 23

Cross Sectional Regression Analysis costquantity data for a number of firms at a given point in time Engineering Method find out the optimal input combination needed to produce various levels of output and multiply the optimal quantity of each input by the price of the input to obtain the longrun cost function of the firm i e LTC curve Survival Technique large and efficient firms drive smaller and less efficient firms out of business in the long run Calculate market share
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Empirical Estimation Long Run Cost Curves

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Slide 24

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Slide 25