EC270 Chapter Notes - Chapter 5: Average Variable Cost, Average Cost, Sunk Costs

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Published on 12 Oct 2012
School
WLU
Department
Economics
Course
EC270
Professor
EC260 Chapter 5 The Analysis of Costs Week 5
-To maximize profit, a manager wishes to produce at an output level where the marginal revenue equals
the marginal cost
-A thorough understanding of cost is necessary for a variety of basic managerial decisions: pricing,
output, transfer pricing cost control, and planning for future production
-Cost considerations include both short-run and long-run components
Opportunity Cost
-Managerial economics define the opportunity cost of producing a particular product as the revenue a
manager could have received is she had used her resources to produce the next best alternative product
or service
-Opportunity cost doctrine the inputs’ values together with production costs determine the economic
cost of production
-Historical cost the money that managers actually paid for an input
-Managerial economists believe historical costs can be misleading
-Explicit costs the ordinary items accountants include as the firm’s expense – payroll, payments or raw
materials, etc.
-Implicit costs the forgone value of resources that managers did not put to their best use
-Economists also follow the doctrine of sunk costs
-Sunk costs sunk costs are resources that are spent and cannot be recovered
-Sunk costs equal the difference between what a resource costs and what it is sold for in the future
-Rational managers must ignore sunk costs and choose between possible strategies by evaluating only
future costs and benefits
Short-run Cost Functions
-Cost function function showing various relationships between input costs and output rate
-Short run the time span between one were the quantity of no input is variable and one where the
quantities of all inputs are variable
-Fixed inputs when the quantities of plan and equipment cannot be altered
-Scale o plant this scale is determined by fixed inputs
-Variable inputs inputs that a manager can vary in quantity in the short run
-Total fixed cost the total cost per period of time incurred for fixed inputs
-Total variable cost the total cost incurred by managers for variable inputs
-Up to a particular output rate, total variable costs rise at a decreasing rate; beyond that outpu level
-Total cost the sum of total fixed and total variable costs
-The total cost function and the total variable cost function have eh same shape because they difer by
only a constant amount, which is total fixed cost
-Managers wan to allocate resources efficiently they want to choose the input bundle that produces a
given output at the lowest possible cost
Average and Marginal Costs
-Average fixed cost the total fixe cost divided by output
-Average variable cost the total variable cost divided by output
-These functions predict the behaviour of costs as output changes
-AFC necessarily declines with increases in output
-AVC tells managers the variable cost, on average f each unit of output
-As output increases, at some point of increased production, AVC rises, this increasing the average
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Document Summary

To maximize profit, a manager wishes to produce at an output level where the marginal revenue equals the marginal cost. A thorough understanding of cost is necessary for a variety of basic managerial decisions: pricing, output, transfer pricing cost control, and planning for future production. Cost considerations include both short-run and long-run components. Managerial economics define the opportunity cost of producing a particular product as the revenue a manager could have received is she had used her resources to produce the next best alternative product or service. Opportunity cost doctrine the inputs" values together with production costs determine the economic cost of production. Historical cost the money that managers actually paid for an input. Managerial economists believe historical costs can be misleading. Explicit costs the ordinary items accountants include as the firm"s expense payroll, payments or raw materials, etc. Implicit costs the forgone value of resources that managers did not put to their best use.

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