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Chapter 5

Chapter 5 EC260.docx

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Wilfrid Laurier University
Karen Huff

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 EC260 Chapter 5 – The Analysis of Costs Week 5 variable cost per unit - Average product = Q/U U=number of input units used -Average total cost – the total cost divided by output -ATC reached its minimum at output levels relatively higher than AVC
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