Managerial Economics Applications, Strategies and Tactics, 14e James R

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Managerial Economics Applications, Strategies and Tactics, 14e James R. McGuigan R. Charles Moyer Frederick H. deB. Harris © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 1 PART III – PRODUCTION AND COST Chapter 8 – Cost Analysis © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 2 Chapter 8 – Cost Analysis Overview • THE MEANING AND MEASUREMENT OF COST • SHORT-RUN COST AND PRODUCT FUNCTIONS • LONG-RUN COST FUNCTIONS • ECONOMIES AND DISECONOMIES OF SCALE © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 3 Ch 8 – The Meaning and Measurement of Cost Accounting versus Economic Costs (1 of 2) • Accountants have been primarily concerned with identifying highly stable and predictable costs for financial reporting purposes • As a result, they define and measure cost by the known certain historical outlay of funds • The price paid for commodity or service inputs, in USD, is one measure of the accounting cost • Interest paid to bondholders or lending institutions is used to measure the accounting cost of funds to the borrower © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 4 Ch 8 – The Meaning and Measurement of Cost Accounting versus Economic Costs (2 of 2) • Economists, on the other hand, have been mainly concerned with measuring costs for decision-making purposes • That objective is different • Opportunity costs: The value of a resource in its next-bet alternative use • Opportunity cost represents the return or compensation that must be foregone as the result of the decision to employ the resource in a given economic activity • Economic profit is defined: © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 5 Ch 8 – The Meaning and Measurement of Cost Three Contrasts between Accounting & Economic Costs (1 of 3) • Depreciation Cost Measurement – The production of a good of service typically requires the use of plant and equipment • Capital assets: A durable input that depreciates with use, time and obsolescence • Depreciation is a loss of asset value, but it is difficult or impossible to determine the exact service life of a capital asset and future changes in its market value • As a result, accountants have adopted standard allocation procedures for assigning a portion of the acquisition cost of an asset to each accounting time period, and to each unit of output produced within that time period © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 6 Table 8.1 – Profitability of Bentley Clothing Store © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 7 Ch 8 – The Meaning and Measurement of Cost Three Contrasts between Accounting & Economic Costs (2 of 3) • Inventory Valuation– When materials are stored in inventory before being used, the accounting and economic costs may differ if the market price of the materials has changed • The accounting cost is equal to the actual acquisition cost • The economic cost is equal to the current replacement cost • Sunk cost – A cost incurred regardless of the alternative action chosen in a decision-making problem • Sunk Cost of Underutilized Facilities – As shown in Table 8.3, a savings results from accepting an offer for less than the firm’s cost © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 8 Table 8.2 – Effect of Inventory Valuation Methods on Measured Profit – Westside Plumbing & Heating Co. © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 9 Table 8.3 – Warehouse Rental Decision – Dunbar Manufacturing Company © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 10 Ch 8 – The Meaning and Measurement of Cost Three Contrasts between Accounting & Economic Costs (3 of 3) • Conclusions– • 1. Costs can be measured indifferent ways, depending on the purpose for which the cost figures are to be used • 2. The costs appropriate for financial reporting purposes are not always appropriate for decision-making purposes. The relevant cost in economic decision making is the opportunity cost of the resources rather than the historical outlay of funds required to obtain the resources © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 11 Ch 8 – Short-Run Cost and Product Functions (1 of 3) • Fixed costs – The costs of inputs to the production process that are constant over the short run • Variable input costs – The costs of the variable inputs to the production process • Average and Marginal Cost Functions © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 12 Ch 8 – Short-Run Cost and Product Functions (2 of 3) • Marginal cost – The incremental increase in total variable cot that results from a one-unit increase in output © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 13 Table 8.4 – Production Function – Deep Creek Mining Company © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 14 Figure 8.1 – Foreign Exchange (FX) Rates: The Value of the U.S. Dollar against Several Major Currencies © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 15 Table 8.5 – Short-run Cost Functions – Deep Creek Mining Company © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 16 Ch 8 – Short-Run Cost and Product Functions (3 of 3) © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 17 Figure 8.2 – Short-Run Average & Marginal Cost Functions – Deep Creek Mining Company © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 18 Figure 8.3 – Long-Run & Short-Run Average Cost Functions © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 19 Ch 8 – Long-Run Cost Functions (1 of 1) • In long-run planning, the firm chooses the optimum combination of inputs to produce the desired level of output at least cost, and some of these inputs become fixed • In the short run, if demand increases unexpectedly, the firm may have little choice but to add additional variable inputs • Should this demand persist, a larger fixed input investment in plant and equipment is warranted, and then unit cost can be reduced • See Figure 8.3 © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 20 Ch 8 – Long-Run Cost Functions Optimal Capacity Utilization: Three Concepts (1 of 1) • Optimal output for a given plant size – Output rate that results in lowest average total cost for a given plant size • Optimal plant size for a given output rate – Plant size that results in lowest average total cost for a given output • Optimal plant size – Plant size that achieves minimum long-run average total cost © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 21 Ch 8 – Economies and Diseconomies of Scale (1 of 1) • Product Level Internal Economies of Scale • Internal economies of scale - Declining long-run average costs as the rate of output for a product, plant, or firm is increased • Learning curve effect – Declining unit cost attributable to greater cumulative from longer production runs • Volume discount – Reduced variable cost attributable to larger purchase orders © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 22 Figure 8.4 – Learning Curve: Arithmetic Scale © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 23 Ch 8 – Economies and Diseconomies of Scale The Percentage of Learning (1 of 1) • Plant-Level Internal Economies of Scale • Sources of scale economies at the plant level include capital investment, overhead, and required reserves of maintenance parts and personnel • Firm-Level Internal Economies of Scale • One possible source is in distribution; multi-plant operations may permit a larger firm to maintain geographically dispersed plants, lowering delivery costs • Diseconomies of Scale • Diseconomies of scale - Rising long-run average total costs as the level of output is increased © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 24 Ch 8 – Economies and Diseconomies of Scale The Overall Effects of Scale Economies and Diseconomies (1 of 2) • For some industries, long-run average total costs for the firm remain constant over a wide range of output once scale economies are exhausted; For others, long-run average total costs rise at a large scale • The possible presence of both economies and diseconomies of scale leas to the hypothesized long-run average cost function for a typical manufacturing firm being U-shaped with a flat middle area • See Figure 8.5 © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 25 Figure 8.5 – Long-Run average Cost Function and Scale Economies © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 26 Ch 8 – Economies and Diseconomies of Scale The Overall Effects of Scale Economies and Diseconomies (2 of 2) • Minimum efficient scale (MES) - The smallest scale at which minimum costs per unit are attained • Up to some MES, the smallest scale at which minimum long-run average total cost are attained, economies of scale are present • In most industries, it is possible to increase the size of the firm beyond this MES without incurring diseconomies of scale • But expansion beyond the maximum efficient scale eventually will result in problems in inflexibility, lack of managerial coordination, and rising long-run average total costs • © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 27 Figure 8.6 – Minimum Efficient Scale (MES) in Autos © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.