Cost Analysis

Mohammad AriefCost Analysis1Overview Economic ScaleCOSTAttracting a resource from its best alternativeManagers seek to produce the highest quality products at the lowest possible cost.Opportunity Cost ConceptFirms that are satisfied with the status quo.The advantages of a large firm have NOT provided the advantages of flexibility and agility found in some smaller companiesCompetitors arise that produce at lower costs Drive them out of businessOperations Activity.Cost analysis is helpful in the task of finding lower cost methods to produce goods and services2Meaning and Measurement of CostsCOSTIn elementary formRefers to the exchange or transformation of resources takes place.Opportunity Economics costCost Information3Accounting vs Economic CostAccounting costs involve explicit historical costs. They attempt to use the same rules for different firms, so we can compare firm performance.Economic costs are based on making decisions. These costs can be both implicit and explicit.A chief example is that economic costs include the opportunity costs of owner-supplied resources such as time and money, which are implicit costs.Economic Profit = the difference between total revenues and these total economic costs, implicit opportunity costs as well as explicit outlays. Total Revenues - Explicit Costs - Implicit CostsBoth explicit and implicit costs make economic profit lower than accounting profit4Contrasts between Accountingand Economic CostsDepreciation Cost Measurement.Accounting depreciation (e.g., straight-line depreciation) tends to have little relationship to the actual loss of valueTo an economist, the actual loss of value is the true cost of using machineryInventory Valuation.Accounting valuation depends on its acquisition costEconomists view the cost of inventory as the cost of replacementUnutilized Facilities.Empty space may appear to have "no costEconomists view its alternative use (e.g., rental value) as its opportunity costSunk Costs.Already paid for, or there already exists a contractual obligation to pay5SHORT-RUN COST FUNCTIONSTo measuring the costs of producing a given quantity of output, economists are also concerned with determining the behavior of costs when output is varied over a range of possible values.Fixed CostVariable CostCost FunctionThe costs of all the inputs to the production process that are fixed or constant over the short runConsist of the costs of all the variable inputs to the production processTC = FC + VC6AFCQQ1.2.AVC3.QAFCAVCATCMC MC intersects lowest point of AVC and lowest point of ATC.

When MC < AVC, AVC declinesWhen MC > AVC, AVC risesShort-Run Cost Graphs7 Relationships Among Cost & Production FunctionsWhen Factor Markets Are Perfectly CompetitiveAP & AVC are inversely related. (ex: one input)AVC = WL /Q = W/ (Q/L) = W/ APLAs APL rises, AVC fallsMP and MC are inversely related MC = dTC/dQ = W dL/dQ = W / (dQ/dL) = W / MPLAs MPL declines, MC risesprod. functionscost functionsMPLLMCAP AVCQQcost88LONG-RUN COST FUNCTIONSOver the long-run planning horizon, using the available production methods and technology, the firm can choose the plant size, types and sizes of equipment, labor skills, and raw materials that, when combined, yield the lowest cost of producing the desired amount of output.Optimal Capacity UtilizationOptimal output for a given plant sizeShort-run concept of capacity utilizationOptimal plant size for a given output rateOptimal plant sizeWill further opportunities for cost reduction ceaseReduced average total cost of any given outputECONOMIES AND DISECONOMIES OF SCALERefer the condition whereas the proportionally output more faster than input.Economic ScaleTechnology Finance Operating Scales increaseSpecialization Productive mechines

A firm size increaseFactors Obligation offeringBank loanBigger transaction (buying or selling the product)1011Economic ScaleProduct-level economiesFirm-level economiesPlant-level economiesWhich include specialization and learning curve effectsWhich are economies in distribution and transportation of a geographically dispersed firm, marketing, sales promotion, or R&D of multi-product firmsSuch as economies in overhead, required reserves, investment, or interactions among products (economies of scope).Rising long-run average costs at higher rates of throughput are attributed.Diseconomic ScaleIndividual production plant is transportation costsLabor requirementsHigher wage ratesRelocation programs may be required to attract the necessary personnelFactors Large-scale plants are often inflexible operations designed for long production runs of one product, based often on forecasts of what the target market wanted in the past12