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Economic Analysis for Managers (ECO 501) Fall:2012 Semester

Economic Analysis for Managers (ECO 501) Fall:2012 Semester. Khurrum S. Mughal. Theme of the Lecture. Cost Theory & Analysis Economic Concept of Cost Short-Run Cost Function Profit Contribution Analysis Breakeven Analysis Operating Leverage. Economic Concept of Cost.

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Economic Analysis for Managers (ECO 501) Fall:2012 Semester

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  1. Economic Analysis for Managers (ECO 501)Fall:2012 Semester Khurrum S. Mughal

  2. Theme of the Lecture • Cost Theory & Analysis • Economic Concept of Cost • Short-Run Cost Function • Profit Contribution Analysis • Breakeven Analysis • Operating Leverage

  3. Economic Concept of Cost • Opportunity costsare the value of the other products that the resources used in production could have produced at their next best alternative • Explicit costs include the ordinary items that an accountant would include as the firms expenses • Implicit costsinclude opportunity costs of resources owned and used by the firm’s owner

  4. Economic Concept of Cost • Normal Profit and Costs • Economic Profit is revenue less economic costs, where the economic costs also include the normal returns to management or capital of the owner. • Cost of Long-Lived Assets • The economic costs of such assets would be the change in market value from the beginning to the end of the period

  5. Economic Concept of Cost • Marginal Costs are the change in total cost due to one unit change in output • Incremental Costsis the additional cost of implementing a managerial decision • Sunk Costs are expenditures that have been made in the past or that are to be made in the future due to some contractual obligation

  6. Theme of the Lecture • Cost Theory & Analysis • Economic Concept of Cost • Short-Run Cost Function • Profit Contribution Analysis • Breakeven Analysis • Operating Leverage

  7. Short-Run A period of time so short that the firm cannot alter the quantity of some of its inputs • Typically plant and equipment are fixed inputs in the short run • Fixed inputs determine the scale of the firm’s operation

  8. Short-Run Cost Functions Total Cost = TC = f(Q) Total Fixed Cost = TFC Total Variable Cost = TVC TC = TFC + TVC

  9. Short-Run Cost Functions

  10. Short-Run Cost Functions TFC

  11. Short-Run Cost Functions Average Total Cost = ATC = TC/Q Average Fixed Cost = AFC = TFC/Q Average Variable Cost = AVC = TVC/Q ATC = AFC + AVC Marginal Cost = TC/Q = TVC/Q

  12. Short-Run Cost Functions

  13. Short-Run Cost Functions

  14. Short-Run Cost Functions

  15. Minimum Average Variable Cost Total Cost Function TC = 1000 + 10Q – 0.9Q2 + 0.04Q3 Rate of output resulting in minimum average variable cost?

  16. Theme of the Lecture • Cost Theory & Analysis • Economic Concept of Cost • Short-Run Cost Function • Profit Contribution Analysis • Breakeven Analysis • Operating Leverage

  17. Profit Contribution Analysis 18 Profit Contribution is the difference between price and average variable cost (P – AVC) You can find out the output rate necessary to cover all fixed costs and earn required profit (πR) FC = $10,000, P = $30, AVC = $28, πR = $20,000

  18. Theme of the Lecture • Cost Theory & Analysis • Economic Concept of Cost • Short-Run Cost Function • Profit Contribution Analysis • Breakeven Analysis • Operating Leverage

  19. Breakeven Analysis 20 A special case where you find the breakeven point by placing πR= 0 FC = $10,000, P = $30, AVC = $28 TC = 10,000 + 28Q TR = 30Q

  20. Linear Breakeven Analysis Linear Breakeven Analysis Revenue, Cost Rate of Output, Q 21

  21. Theme of the Lecture • Cost Theory & Analysis • Economic Concept of Cost • Short-Run Cost Function • Profit Contribution Analysis • Breakeven Analysis • Operating Leverage

  22. Operating Leverage 23 If fixed costs are relatively large than variable costs the firm is said to be highly leveraged It experiences more variation in profit for a percentage change in output. Can be analyzed using profit elasticity Eπ

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