Chapter 13 – Short-Run Decision Making:
SHORT-RUN DECISION MAKING
The Decision Making Model
A decision model, a specific set of procedures that produces a decision, can be used to
structure the decision maker’s thinking and organize the info to make a good decision.
The following is an outline of one-decision making model:
Step 1: Define the Problem
Recognize and define a specific problem.
Step 2: Identify the Alternatives
List and consider possible solutions.
Step 3: Identify the Costs and Benefits Associated with Each Feasible Alternative
The costs and benefits associated with each feasible alternative are identified.
At this point, clearly irrelevant costs can be eliminated from consideration.
Step 4: Estimate the Relevant Costs and Benefits for Each Feasible Alternative
The differential cost is the difference between the summed costs of two alternatives in a
It compares the sum of each alternative’s relevant costs only.
Step 5: Assess the Qualitative Factors
While the costs and revenues associated with the alternatives are important, they don’t tell
the whole story.
Qualitative factors can significantly affect the manager’s decision.
Political factors, product safety, quality, reliability of supply…
Step 6: Make the Decision
Once all relevant costs and benefits for each alternative have been assessed and the
qualitative factors weighed, a decision can be made.
RELEVANT COST DEFINED
Relevant costs possess two characteristics: they are future costs and they differ across
If a future cost is the same for more than one alternative, it has no effect in the
decision, which makes it irrelevant.
If future benefits differ across alternatives, then they are relevant and should be
included in the analysis. Relevant Cost Illustrated
Opportunity cost is the benefit sacrificed or forgone when one alternative is chosen over
another, which makes it a relevant cost.
While it’s never an accounting cost, because accountants don’t record the cost of what
might happen in the future, it’s an important consideration in decision making.
For example, if you are deciding if or not to go to school full-time or work full-time, the
opportunity cost of going to school would be the wages you sacrifice by not working.
Irrelevant Past Cost Illustrated
Depreciation represents an allocation of a cost already incurred.
It’s a sunk cost, a cost that cannot be affected by any future action. They’re always the
same across alternatives, therefore making them irrelevant.
Irrelevant Future Cost Illustrated
Example – Company currently pays an Internet provide $5k/year to store its website on the
service. Since it intends to keep the Web page no matter what, that cost is not relevant to the
COST BEHAVIOUR AND RELEVANT COSTS
It’s easy to fall into the trap of believing that variable costs are relevant and fixed costs aren’t,
but that assumption is untrue.
SOME COMMON RELEVANT COST APPLICATION
The following applications include decisions:
To outsource services or production (make or buy)
To accept a special order at less than the usual price
To keep or drop a segment or product