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BUS 207 (14)
Chapter 6

Chapter 6 Vocab and Notes

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Business Administration
BUS 207
Karen Ruckman

Managerial EconomicsChapter 6 Cost AnalysisRELEVANT COSTSIn deciding among different courses of action the manager need only consider the differential revenues and costs of the alternativesThe only relevant costs are those that differ across alternative courses of actionOpportunity Costs and Economic ProfitsThe Opportunity Cost associated with choosing a particular decision is measured by the benefits forgone in the nextbest alternativeExample What is the opportunity cost of pursuing an MBA degree What is the opportunity cost that should be imputed to cityowned land that is to be the site of a public parking garage downtownOpportunity costs for goods services or inputs often are determined by market pricesThe basic rule for optimal decision making is Undertake a given course of action if and only if its incremental benefits exceed its incremental costs including opportunity costsEconomic ProfitProfit is the difference between revenues and costsAccounting Profit is the difference between revenues obtained and expenses incurredWith respect to managerial decision making the accounting measure does not present the complete story concerning profitabilityEconomic Profit is the difference between revenues and all economic costs explicit and implicit including opportunity costsIt involves costs associated with capital and with managerial labourStarting a BusinessIn general economic profit is zero if total revenues are exactly matched by total costs where total costs include a normal return to any capital invested in the decision and other income forgoneNormal return means the return required to compensate the suppliers of capital for bearing the risk of the investmentFixed and Sunk CostsCosts that are Fixed do not vary with respect to different courses of action under consideration are irrelevant and need not be considered by the managerIf the manager computes each alternatives profit the same fixed cost is subtracted in each case so therefore the fixed cost itself plays no role in determining the relative merits of the actionsWith respect to a shutdown decision many of the previous fixed costs become variableIgnoring fixed costs is important because it saves considerable computation and it forces managers to focus on the differential costs that are relevantA Sunk cost is an expense that already has been incurred and cannot be recovered
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