business costs - aws · pdf filekey concepts –short run costs average cost total cost...

BusinessCosts

GeoffRileyFRSACo-Founderoftutor2u

ShortRun• Atleastoneofthefactorinputsisfixed(usuallythisiscapitalbutcanalsobeland).Intheshortrun,businessesareconstrainedwithfixed&variablefactors.

LongRun• Allfactorsofproductionarevariableandthescaleofproductioncanalsochangeallowingthefirmtobenefitfromeconomies ofscale

TheShortRunandtheLongRun

Keyevaluationpoint:Thelengthoftheshortrunwillvarybyindustry

TheShortRunandtheLongRun

TheShortRunandtheLongRunFixedCosts

Fixedcostsdonot vary asthelevelofoutputchangesintheshortrun

Thehighertheleveloffixedcostsinabusiness,thehighermustbetheoutputinordertobreak-even

TheShortRunandtheLongRunVariableCosts

Variable costsarecoststhatrelatedirectlytotheproductionorsaleofaproduct

Variablecostisdeterminedbythemarginalcostofextraunits ofoutput

Fixedorvariablecost?Typeyouranswerinthechatwindow!

Workplaceproductivitysoftware

Cloudcomputingservices

Keyevaluationpoint:Advancesindigitaltechnologiesmeanthatmanyfixedcostshavebecomevariablecosts.

Consultingfees RentalCosts MarketingBudgets

ResearchProjects Fixedsalarycosts Businessinsurance

FixedCosts

CommissionBonuses WageCosts Componentparts

Basicrawmaterials Energyandfuelcosts Packagingcosts

VariableCosts

Output TotalCost(£)

AverageTotalCost(£)

MarginalCost(£)

0 2000

50 2500 50 10

100 2700 27 4

150 2850 19 3

200 3000 15 3

250 3250 13 5

300 3900 13 13

350 4550 13 13

400 5600 14 21

MC<AC;ACfalling

MC<AC;ACfalling

MC<AC;ACfalling

MC<AC;ACfalling

MC<AC;ACfalling

MC=AC;ACconstant

MC=AC;ACconstant

MC>AC;ACrising

ChangingMarginalCostasOutputRises

MC1Cost

Output

AC1

MC2

AC2

Ariseinvariablecostsofproductionleadstoanupwardshiftbothinmarginalandaveragetotalcost

ShowingaRiseinVariableCosts

EconomiesofScale

LongRunCostsandReturnstoScale

Internaleconomiesofscale

Expansionofthefirmitself

Lowerlongrunaveragecost(LRAC)asoutputincreases

Externaleconomiesofscale

Expansionoftheindustryofwhichthefirmisamember

Benefitsmost/allfirms

InternalandExternalEconomiesofScale

InternalorExternalEconomyofScale?Typeyouranswerinthechatwindow!

University ScienceParklowersthecostsof

research

Smallbusinesslowerstheirpurchasingcostsusing agiantwholesaler

ExternalEconomy InternalEconomy

Q1

AverageCost(UnitCost)

Output

LRAC

Q2 Q3

EconomiesofscalecauseACtofall

LowestpointonLRACisoutputof

productiveefficiency

Economiesofscalearisefromincreasingreturnstoscaleinthelongrun

RisingLRAC– meansdiseconomiesofscale

InternalEconomiesofScale

Overview:ImpactofScaleEconomiesChange: EconomiesofScale

Output Higher

Profitmaximisingprice Lower

Total profit Higher

Producersurplus Higher

Consumersurplus Higher

Theeffectofscaleeconomiesisanimportantaspecttoconsiderwhenanalysingandevaluatingmarketpower

Overview:ImpactofScaleEconomies

KeyConcepts– ShortRunCostsAverageCost Totalcostperunitofoutput=Totalcost/

output=TC/Q

AverageFixedCost Totalfixedcostperunitofoutput=TFC/Q

AverageVariableCost Totalvariablecostperunitofoutput=TVC/Q

DiminishingReturns Additionofavariablefactortoafixedfactorresultsinafallinmarginalproduct

FixedCost Businessexpensethatdoesnotvarydirectlywiththelevelofoutput

Marginalcost Thechangeintotalcostsfromincreasingoutputbyoneextraunit

KeyConcepts– ShortRunCosts

KeyConcepts– LongRunCosts

ConstantreturnstoscaleWhenlongrunaverage cost(LRAC) remainsconstantasoutputincreasesbecauseoutputisrisinginproportionto theinputsused

Diseconomiesofscale Abusinessmayexpandbeyondtheoptimalsizeandsee risingLongRunAverageCost(LRAC)

Economiesofscope Whereitischeapertoproducearangeofproducts–costsavingsfromproductdiversification

ExternaleconomiesofscaleWhenexpansionofanindustryleadstothegrowthofancillaryservicescausingadownwardslopingindustrysupplycurve

IncreasingreturnstoscaleThismeanseconomiesofscale,whenoutputisrisingfasterthaninputswhenallinputscanbevariedinthelongrun

MinimumefficientscaleWhereinternaleconomiesofscalehavebeenfullyexploited.This correspondstothelowestpointonthefirm’slongrunaveragecostcurve (LRAC)

KeyConcepts– LongRunCosts