Managerial Economics Jack Wu
Cost and economies of scale Cost and economies of scope Relevant / Irrelevant costs Direct / Indirect costs
average cost marginal, average variable cost Production rate (Thousands a day) Marginal/average cost ($ per unit) Economies of Scale
large fixed costs ◦ research, development, and design ◦ information technology falling average variable costs ◦ distribution of gas and water ◦ container ships
large-scale production seller side: monopoly/oligopoly buyer side: monopsony/oligopsony
Expenses for two products
source -- joint cost: cost of inputs that do not change with scope of production examples: Qwest ’ s IP network: voice + data cable television + telephony strategic implication -- produce/deliver multiple products
consider only relevant costs and ignore all other costs ◦ which costs are relevant depends on course of action relevant costs may be hidden irrelevant costs may be shown in accounts
definition -- net revenue from best alternative course of action two approaches show alternatives report opportunity costs
Williams bought a warehouse and paid $300,000 for it. She used her own money $200,000 and made a bank loan of $100,000. A developer were willing to buy warehouse for 2 million. If Williams sells warehouse, she could invest proceeds in government bonds and get a secure income $160,000 (2 million*8%). She could work elsewhere for salary $400,000.
Income statement reporting opportunity costs Income statement showing alternatives Income statement showing alternatives
definition -- cost that has been committed and cannot be avoided alternative courses of action prior commitments planning horizon Fewer commitments fewer sunk costs; longer planning horizon fewer sunk costs.
Jupiter Athletic is about to launch a line of new athletic shoes. Some month ago, management prepared an ad campaign with total budget of $310,000. They forecast the ad would generate sales of 20,000 units. Each sale’s unit contribution margin (price- average variable cost) is $20. The total contribution margin is $20*20000=$400,000. Their expected profit generated from ad is $400, ,000=$90,000.
Recently, a major competitor launch a new shoe. Jupiter estimates sales fall to 15,000 units. The contribution margin becomes $20*15,000=$300,000. Should Jupiter cancel the launch?
Income statement omitting sunk costs Income statement showing alternatives
lock in customers lock out competitors
Not all sunk costs are fixed Not all fixed costs are sunk
direct cost: can be relatively easily identified with a particular product/job activity-based costing ◦ identify the activities ◦ allocate the indirect cost of each activity among the products ◦ combine the allocated indirect costs with the direct costs
One indirect cost centre is shipping department -- accounting statements show: _wages _telephone and fax Must investigate to allocate: identify two activities _shipments _handling enquiries
itemexpenseshipmtinquirie s method wages48,00030,00018,000worker hours tel/fax 2,000 0 identified total50,00030,00020,000
shipmtsinquiries Alpha Beta Wkly expense$600$400 Alloc: Alpha$600 x 5/13$400 x 10/26 Alloc: Beta$600 x 8/13$400 x 16/26