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The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk Costs are Irrelevant

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Page 1: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

The Nature of CostsExplicit Costs

Accounting CostsEconomic Costs

Implicit CostsAlternative or Opportunity Costs

Relevant CostsIncremental CostsSunk Costs are Irrelevant

Page 2: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Short-Run Cost FunctionsTotal Cost = TC = f(Q)

Total Fixed Cost = TFC

Total Variable Cost = TVC

TC = TFC + TVC

Page 3: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Short-Run Cost FunctionsAverage Total Cost = ATC = TC/Q

Average Fixed Cost = AFC = TFC/Q

Average Variable Cost = AVC = TVC/Q

ATC = AFC + AVC

Marginal Cost = TC/Q = TVC/Q

Page 4: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Short-Run Cost Functions

Q TFC TVC TC AFC AVC ATC MC0 $60 $0 $60 - - - -1 60 20 80 $60 $20 $80 $202 60 30 90 30 15 45 103 60 45 105 20 15 35 154 60 80 140 15 20 35 355 60 135 195 12 27 39 55

Page 5: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Page 6: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Short-Run Cost FunctionsAverage Variable Cost

AVC = TVC/Q = w/APL

Marginal Cost

TC/Q = TVC/Q = w/MPL

Page 7: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Long-Run Cost CurvesLong-Run Total Cost = LTC = f(Q)

Long-Run Average Cost = LAC = LTC/Q

Long-Run Marginal Cost = LMC = LTC/Q

Page 8: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Derivation of Long-Run Cost Curves

Page 9: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Relationship Between Long-Run and Short-Run Average Cost Curves

Page 10: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Possible Shapes ofthe LAC Curve

Page 11: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Learning CurvesAverage Cost of Unit Q = C = aQb

Estimation Form: log C = log a + b Log Q

Page 12: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Minimizing Costs InternationallyForeign Sourcing of InputsNew International Economies of ScaleImmigration of Skilled LaborBrain Drain

Page 13: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Cost-Volume-Profit AnalysisTotal Revenue = TR = (P)(Q)

Total Cost = TC = TFC + (AVC)(Q)

Breakeven Volume TR = TC

(P)(Q) = TFC + (AVC)(Q)

QBE = TFC/(P - AVC)

Page 14: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Cost-Volume-Profit AnalysisP = 40

TFC = 200

AVC = 5

QBE = 40

Page 15: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Operating LeverageOperating Leverage = TFC/TVC

Degree of Operating Leverage = DOL

% ( )

% ( )

Q P AVCDOL

Q Q P AVC TFC

Page 16: The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk

Operating LeverageTC’ has a higher DOL than TC and therefore a higher QBE

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