Cost Analysis by MARK HIRSHEY

1. Cost Analysis and Estimation

2. What Makes Cost Analysis Difficult • Opportunity Cost • Incremental and Sunk Costs in Decision Analysis • Short-run and Long-run Costs • Short-run Cost Curves • Long-run Cost Curves • Minimum Efficient Scale • Firm Size and Plant Size • Learning Curves • Economies of Scope • Cost-volume-profit Analysis

3. historical cost current cost replacement cost opportunity cost explicit cost implicit cost incremental cost profit contribution sunk cost cost function short-run cost functions long-run cost functions short run long run planning curves operating curves fixed cost variable cost short-run cost curve long-run cost curve economies of scale cost elasticity capacity minimum efficient scale multiplant economies of scale multiplant diseconomies of scale learning curve economies of scope cost-volume-profit analysis breakeven quantity KEY CONCEPTS

4. Opportunity Cost • Opportunity Cost Concept • Opportunity cost is foregone value. • Reflects second-best use. • Explicit and Implicit Costs • Explicit costs are cash expenses. • Implicit costs are noncash expenses.

5. Incremental and Sunk Costs in Decision Analysis • Incremental Cost • Incremental cost is the change in cost tied to a managerial decision. • Incremental cost can involve multiple units of output. • Marginal cost involves a single unit of output. • Sunk Cost • Irreversible expenses incurred previously. • Sunk costs are irrelevant to present decisions.

6. Short-run and Long-run Costs • How Is the Operating Period Defined? • At least one input is fixed in the short run. • All inputs are variable in the long run. • Fixed and Variable Costs • Fixed cost is a short-run concept. • All costs are variable in the long run.

7. Short-run Cost Curves • Short-run Cost Categories • Total Cost = Fixed Cost + Variable Cost • For averages, ATC = AFC + AVC • Marginal Cost, MC = ∂TC/∂Q • Short-run Cost Relations • Short-run cost curves show minimum cost in a given production environment.

10. Long-run Cost Curves • Economies of Scale • Long-run cost curves show minimum cost in an ideal environment.

13. Cost Elasticity and Economies of Scale • Cost elasticity is εC = ∂C/C ÷ ∂Q/Q. • εC < 1 means falling AC, increasing returns. • εC = 1 means constant AC constant returns. • εC > 1 means rising AC, decreasing returns.

14. Long-run Average Costs

15. Minimum Efficient Scale • Competitive Implications of Minimum Efficient Scale • MES is the minimum point on the LRAC curve. • Competition is most vigorous when: • MES is small in absolute terms. • MES is a small share of industry output. • Disadvantage to less than MES scale is modest.

16. Transportation Costs and MES • Terminal, line-haul and inventory costs can be important. • High transport costs reduce MES impact.

21. Economies of Scope • Economies of Scope Concept • Scope economies are cost advantages that stem from producing multiple outputs. • Big scope economies explain the popularity of multi-product firms. • Without scope economies, firms specialize. • Exploiting Scope Economies • Scope economics often shape competitive strategy for new products.

22. Cost-volume-profit Analysis • Cost-volume-profit Charts • Cost-volume-profit analysis shows effects of varying scale. • Breakeven analysis shows zero profit points of cost coverage.

24. Degree of Operating Leverage • DOL=Q(P-AVC)/[Q(P-AVC)-TFC] • DOL is the elasticity of profit with respect to output.