PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Managerial Economics in a Global Economy.

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PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Managerial Economics in a Global Economy Chapter 7 Cost Theory and Estimation

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Nature of Costs Explicit Costs –Accounting Costs Economic Costs –Implicit Costs –Alternative or Opportunity Costs Relevant Costs –Incremental Costs –Sunk Costs are Irrelevant

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Short-Run Cost Functions Total Cost = TC = f(Q) Total Fixed Cost = TFC Total Variable Cost = TVC TC = TFC + TVC

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Short-Run Cost Functions

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Short-Run Cost Functions Average Variable Cost AVC = TVC/Q = w/AP L Marginal Cost  TC/  Q =  TVC/  Q = w/MP L

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Derivation of Long-Run Cost Curves

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Relationship Between Long-Run and Short-Run Average Cost Curves

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Possible Shapes of the LAC Curve

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Learning Curves Average Cost of Unit Q = C = aQ b Estimation Form: log C = log a + b Log Q

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Minimizing Costs Internationally Foreign Sourcing of Inputs New International Economies of Scale Immigration of Skilled Labor Brain Drain

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost-Volume-Profit Analysis Total Revenue = TR = (P)(Q) Total Cost = TC = TFC + (AVC)(Q) Breakeven Volume TR = TC (P)(Q) = TFC + (AVC)(Q) Q BE = TFC/(P - AVC)

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Cost-Volume-Profit Analysis P = 40 TFC = 200 AVC = 5 Q BE = 40

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Operating Leverage Operating Leverage = TFC/TVC Degree of Operating Leverage = DOL

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Operating Leverage TC’ has a higher DOL than TC and therefore a higher Q BE

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. 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

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Empirical Estimation Functional Form for Short-Run Cost Functions Theoretical FormLinear Approximation

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Empirical Estimation Theoretical FormLinear Approximation

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Empirical Estimation Long-Run Cost Curves Cross-Sectional Regression Analysis Engineering Method Survival Technique

PowerPoint Slides by Robert F. BrookerHarcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Empirical Estimation Actual LAC versus empirically estimated LAC’