1. Managerial Economics Jack Wu

2.  Cost and economies of scale  Cost and economies of scope  Relevant / Irrelevant costs  Direct / Indirect costs

5. 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 102030405060708090 average cost marginal, average variable cost Production rate (Thousands a day) Marginal/average cost ($ per unit) Economies of Scale

6.  large fixed costs ◦ research, development, and design ◦ information technology  falling average variable costs ◦ distribution of gas and water ◦ container ships

7.  large-scale production  seller side: monopoly/oligopoly  buyer side: monopsony/oligopsony

8. Expenses for two products

9.  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

10.  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

11.  definition -- net revenue from best alternative course of action  two approaches  show alternatives  report opportunity costs

12.  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.

13. Income statement reporting opportunity costs Income statement showing alternatives Income statement showing alternatives

14.  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.

15.  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- 310,000=$90,000.

16.  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?

17. Income statement omitting sunk costs Income statement showing alternatives

18.  lock in customers  lock out competitors

19.  Not all sunk costs are fixed  Not all fixed costs are sunk

20.  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

21.  One indirect cost centre is shipping department -- accounting statements show: _wages _telephone and fax  Must investigate to allocate: identify two activities _shipments _handling enquiries

22. itemexpenseshipmtinquirie s method wages48,00030,00018,000worker hours tel/fax 2,000 0 identified total50,00030,00020,000

23. shipmtsinquiries Alpha5001000 Beta8001600 Wkly expense$600$400 Alloc: Alpha$600 x 5/13$400 x 10/26 Alloc: Beta$600 x 8/13$400 x 16/26