1. Economic Analysis for Managers (ECO 501) Fall:2012 Semester
Khurrum S. Mughal

2. Theme of the Lecture Cost Theory & Analysis Economic Concept of Cost
Short-Run Cost Function
Profit Contribution Analysis
Breakeven Analysis
Operating Leverage

3. Economic Concept of Cost
Opportunity costs are the value of the other products that the resources used in production could have produced at their next best alternative
Explicit costs include the ordinary items that an accountant would include as the firms expenses
Implicit costs include opportunity costs of resources owned and used by the firm’s owner

4. Economic Concept of Cost
Normal Profit and Costs
Economic Profit is revenue less economic costs, where the economic costs also include the normal returns to management or capital of the owner.
Cost of Long-Lived Assets
The economic costs of such assets would be the change in market value from the beginning to the end of the period

5. Economic Concept of Cost
Marginal Costs are the change in total cost due to one unit change in output
Incremental Costs is the additional cost of implementing a managerial decision
Sunk Costs are expenditures that have been made in the past or that are to be made in the future due to some contractual obligation

6. Theme of the Lecture Cost Theory & Analysis Economic Concept of Cost
Short-Run Cost Function
Profit Contribution Analysis
Breakeven Analysis
Operating Leverage

7. Short-Run
A period of time so short that the firm cannot alter the quantity of some of its inputs
Typically plant and equipment are fixed inputs in the short run
Fixed inputs determine the scale of the firm’s operation

8. Total Variable Cost = TVC
Short-Run Cost Functions
Total Cost = TC = f(Q)
Total Fixed Cost = TFC
Total Variable Cost = TVC
TC = TFC + TVC

9. Short-Run Cost FunctionsQ
TFC
TVC TC 60 1 20 80 2 30 90 3 45
105 4
140 5
135
195

10. Short-Run Cost Functions
TFC

11. Average Total Cost = ATC = TC/Q Average Fixed Cost = AFC = TFC/Q
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

12. Short-Run Cost FunctionsQ
TFC
TVC TC
AFC
AVC
ATC MC 60 - 1 20 80 ? 2 30 90 3 45
105 4
140 5
135
195

13. Short-Run Cost FunctionsQ
TFC
TVC TC
AFC
AVC
ATC MC 60 - 1 20 80 2 30 90 15 45 10 3
105 35 4
140 5
135
195 12 27 39 55

14. Short-Run Cost Functions

16. Rate of output resulting in minimum average variable cost?
Total Cost Function
TC = Q – 0.9Q Q3
Rate of output resulting in minimum average variable cost?

17. Theme of the Lecture Cost Theory & Analysis Economic Concept of Cost
Short-Run Cost Function
Profit Contribution Analysis
Breakeven Analysis
Operating Leverage

18. Profit Contribution Analysis
Profit Contribution is the difference between price and average variable cost (P – AVC)
You can find out the output rate necessary to cover all fixed costs and earn required profit (πR)
FC = $10,000, P = $30, AVC = $28, πR = $20,000 18

19. Theme of the Lecture Cost Theory & Analysis Economic Concept of Cost
Short-Run Cost Function
Profit Contribution Analysis
Breakeven Analysis
Operating Leverage

20. Breakeven Analysis
A special case where you find the breakeven point by placing πR= 0
FC = $10,000, P = $30, AVC = $28
TC = 10, Q
TR = 30Q 20

21. Linear Breakeven Analysis
Revenue, Cost
Rate of Output, Q
Linear Breakeven Analysis 21

22. Theme of the Lecture Cost Theory & Analysis Economic Concept of Cost
Short-Run Cost Function
Profit Contribution Analysis
Breakeven Analysis
Operating Leverage

23. Operating Leverage
If fixed costs are relatively large than variable costs the firm is said to be highly leveraged
It experiences more variation in profit for a percentage change in output.
Can be analyzed using profit elasticity Eπ 23