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Philippine Christian University

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Managerial Economics

Concepts

Cost Allocation and Estimation

Submitted by:
Levi L. Eugenio
Floyd C. Paguio
Homer Deo Datu Estavillo
Reynaldo Bautista
Sheik rahman
Beatrix Rose Beltijar
Marthin Sitompul
Thu Thanh La

Submitted to:
Prof. Neil Bermudez
January 30, 2016

Cost Analysis and Estimation

OVERVIEW

KEY

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
CONCEPTS
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
What Makes Cost Analysis Difficult?
Link Between Accounting and Economic Valuations
Accounting and economic costs often differ.
Historical Versus Current Costs
Historical cost is the actual cash outlay.
Current cost is the present cost of previously acquired items.
Replacement Cost
Cost of replacing productive capacity using current technology.
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.
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.
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.
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.

Long-run Cost Curves

Economies of Scale
Long-run cost curves show minimum cost in an ideal environment.

Cost Elasticity and Economies of Scale

Cost elasticity is C = C/C Q/Q.


C < 1 means falling AC, increasing returns.
C = 1 means constant AC constant returns.
C > 1 means rising AC, decreasing returns.

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.

Transportation Costs and MES


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

Firm Size and Plant Size


Multi-plant Economies and Diseconomies of Scale
Multi-plant economies are cost advantages from operating
several plants.
Multi-plant diseconomies are cost disadvantages from operating
several plants.

Economics of Multi-plant Operation: an Example


Plant Size and Flexibility

Learning Curves
Learning Curve Concept
Learning causes an inward shift in the LRAC curve.
Learning curve advantages are often mistaken for economies of
scale effects.
Learning Curve Example
Strategic Implications of the Learning Curve Concept
When learning results in 20% to 30% cost savings, it becomes a
key part of competitive strategy.

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.

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.

Degree of Operating Leverage


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

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