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Business Costs Geoff Riley FRSA Co-Founder of tutor2u

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Page 1: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

BusinessCosts

GeoffRileyFRSACo-Founderoftutor2u

Page 2: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

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

LongRun• Allfactorsofproductionarevariableandthescaleofproductioncanalsochangeallowingthefirmtobenefitfromeconomies ofscale

TheShortRunandtheLongRun

Keyevaluationpoint:Thelengthoftheshortrunwillvarybyindustry

TheShortRunandtheLongRun

Page 3: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

TheShortRunandtheLongRunFixedCosts

Fixedcostsdonot vary asthelevelofoutputchangesintheshortrun

Thehighertheleveloffixedcostsinabusiness,thehighermustbetheoutputinordertobreak-even

Page 4: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

TheShortRunandtheLongRunVariableCosts

Variable costsarecoststhatrelatedirectlytotheproductionorsaleofaproduct

Variablecostisdeterminedbythemarginalcostofextraunits ofoutput

Page 5: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

Fixedorvariablecost?Typeyouranswerinthechatwindow!

Workplaceproductivitysoftware

Cloudcomputingservices

Keyevaluationpoint:Advancesindigitaltechnologiesmeanthatmanyfixedcostshavebecomevariablecosts.

Page 6: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

Consultingfees RentalCosts MarketingBudgets

ResearchProjects Fixedsalarycosts Businessinsurance

FixedCosts

Page 7: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

CommissionBonuses WageCosts Componentparts

Basicrawmaterials Energyandfuelcosts Packagingcosts

VariableCosts

Page 8: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

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

Page 9: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

MC1Cost

Output

AC1

MC2

AC2

Ariseinvariablecostsofproductionleadstoanupwardshiftbothinmarginalandaveragetotalcost

ShowingaRiseinVariableCosts

Page 10: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

EconomiesofScale

LongRunCostsandReturnstoScale

Page 11: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

Internaleconomiesofscale

Expansionofthefirmitself

Lowerlongrunaveragecost(LRAC)asoutputincreases

Externaleconomiesofscale

Expansionoftheindustryofwhichthefirmisamember

Benefitsmost/allfirms

InternalandExternalEconomiesofScale

Page 12: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

InternalorExternalEconomyofScale?Typeyouranswerinthechatwindow!

University ScienceParklowersthecostsof

research

Smallbusinesslowerstheirpurchasingcostsusing agiantwholesaler

ExternalEconomy InternalEconomy

Page 13: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

Q1

AverageCost(UnitCost)

Output

LRAC

Q2 Q3

EconomiesofscalecauseACtofall

LowestpointonLRACisoutputof

productiveefficiency

Economiesofscalearisefromincreasingreturnstoscaleinthelongrun

RisingLRAC– meansdiseconomiesofscale

InternalEconomiesofScale

Page 14: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

Overview:ImpactofScaleEconomiesChange: EconomiesofScale

Output Higher

Profitmaximisingprice Lower

Total profit Higher

Producersurplus Higher

Consumersurplus Higher

Theeffectofscaleeconomiesisanimportantaspecttoconsiderwhenanalysingandevaluatingmarketpower

Overview:ImpactofScaleEconomies

Page 15: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

KeyConcepts– ShortRunCostsAverageCost Totalcostperunitofoutput=Totalcost/

output=TC/Q

AverageFixedCost Totalfixedcostperunitofoutput=TFC/Q

AverageVariableCost Totalvariablecostperunitofoutput=TVC/Q

DiminishingReturns Additionofavariablefactortoafixedfactorresultsinafallinmarginalproduct

FixedCost Businessexpensethatdoesnotvarydirectlywiththelevelofoutput

Marginalcost Thechangeintotalcostsfromincreasingoutputbyoneextraunit

KeyConcepts– ShortRunCosts

Page 16: Business Costs - AWS · PDF fileKey Concepts –Short Run Costs Average Cost Total cost per unit of output = Total cost / output = TC/Q Average Fixed Cost Total fixed cost per unit

KeyConcepts– LongRunCosts

ConstantreturnstoscaleWhenlongrunaverage cost(LRAC) remainsconstantasoutputincreasesbecauseoutputisrisinginproportionto theinputsused

Diseconomiesofscale Abusinessmayexpandbeyondtheoptimalsizeandsee risingLongRunAverageCost(LRAC)

Economiesofscope Whereitischeapertoproducearangeofproducts–costsavingsfromproductdiversification

ExternaleconomiesofscaleWhenexpansionofanindustryleadstothegrowthofancillaryservicescausingadownwardslopingindustrysupplycurve

IncreasingreturnstoscaleThismeanseconomiesofscale,whenoutputisrisingfasterthaninputswhenallinputscanbevariedinthelongrun

MinimumefficientscaleWhereinternaleconomiesofscalehavebeenfullyexploited.This correspondstothelowestpointonthefirm’slongrunaveragecostcurve (LRAC)

KeyConcepts– LongRunCosts


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