lecture seven: costs
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Lecture Seven: Costs. IPEM Tohoku University Managerial Economics Lecturer: Jack Wu Period 1/February 17. Economies of scale. Economies of scale (increasing returns to scale): average cost decreases with scale of production. Scale Economies: Sources. large fixed costs - PowerPoint PPT PresentationTRANSCRIPT
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LECTURE SEVEN:COSTS
IPEM Tohoku University
Managerial Economics
Lecturer: Jack Wu
Period 1/February 17
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ECONOMIES OF SCALE
Economies of scale (increasing returns to scale): average cost decreases with scale of production
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SCALE ECONOMIES: SOURCES
large fixed costs research, development, and design information technology
falling average variable costs distribution of gas and water container ships
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DISECONOMIES OF SCALE
Definition: Diseconomies of scale (decreasing returns to scale) – average cost increases with scale of production
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ECONOMIES OF SCALE: STRATEGIC IMPLICATIONS
Either produce on large scale or outsource Seller side – monopoly/oligopoly Buyer side – monopsony/oligopsony
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ECONOMIES OF SCALE:GOOGLE VIS-À-VIS LIBRARY
Which link(s) in service chain are scaleable? Compilation of information Providing service: servers and network Responding to enquiries
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ECONOMIES OF SCOPE
Economies of scope: total cost of production is lower with joint than with separate production
Diseconomies of scope: total cost of production is higher with joint than with separate production
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Organization Output Labor Printing Ink etc. TotalPress Cost
Separate production Daily Globe 50,000 $5,000 $3,500 $6,700 $15,200 Afternoon Globe 50,000 $5,000 $3,500 $6,700 $15,200 Two papers $30,400Combined production Two papers 100,000$10,000 $3,500 $13,400 $26,900
EXPENSES FOR TWO PRODUCTS
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ECONOMIES OF SCOPE
source -- joint cost: cost of inputs that do not change with scope of production
examples:� cable television + telephone banking + insurance
strategic implication -- produce/deliver multiple products
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RELEVANCE
consider only relevant costs and ignore all other costs which costs are relevant depends on course of
action relevant costs may be hidden irrelevant costs may be shown in accounts
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OPPORTUNITY COST
definition -- net revenue from best alternative course of action
two approaches� show alternatives� report opportunity costs
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EXAMPLE Williams bought a warehouse and paid
$300,000 for it. She used her own money $200,000 and made a bank loan of $100,000.
A developer were willing to buy warehouse for 2 million.
If Williams sells warehouse, she could invest proceeds in government bonds and get a secure income $160,000 (2 million*8%).
She could work elsewhere for salary $400,000.
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Continue Warehouse Operations
Shutdown
Revenue $700,000 $560,000 Expenses $220,000 $0
Profit $480,000 $560,000
Revenue $700,000
Cost $780,000
Profit ($80,000)
Income statement reporting opportunity costs
INCOME STATEMENT SHOWING ALTERNATIVES
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SUNK COST
definition -- cost that has been committed and cannot be avoided
alternative courses of action� prior commitments� planning horizon
Fewer commitments fewer sunk costs;
longer planning horizon fewer sunk costs.
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EXAMPLE Jupiter Athletic is about to launch a line of
new athletic shoes. Some month ago, management prepared an ad campaign with total budget of $310,000.
They forecast the ad would generate sales of 20,000 units. Each sale’s unit contribution margin (price- average variable cost) is $20. The total contribution margin is $20*20000=$400,000. Their expected profit generated from ad is $400,000-310,000=$90,000.
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EXAMPLE: CONTINUED
Recently, a major competitor launch a new shoe. Jupiter estimates sales fall to 15,000 units. The contribution margin becomes $20*15,000=$300,000.
Should Jupiter cancel the launch?
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Continue Product Launch
Cancel Launch
Contribution margin $300,000 $0 Graphic arts
consultant fee $50,000 $50,000
Road Runner charge $60,000 $30,000 Daily Globe charge $200,000 $20,000
Profit ($10,000) ($100,000)
Contribution margin $300,000 Graphic arts cost $0
Road Runner charge $30,000 Daily Globe charge $180,000
Profit $90,000
Income statement omitting sunk costs
INCOME STATEMENT SHOWING ALTERNATIVES