Docstoc

Costs

Document Sample
Costs Powered By Docstoc
					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
     research, development, and design
     information technology

   falling average variable costs
     distribution of gas and water
     container ships
DISECONOMIES OF SCALE
   Definition: Diseconomies of scale (decreasing
    returns to scale) – average cost increases with
    scale of production
ECONOMIES OF SCALE:
STRATEGIC IMPLICATIONS
   Either produce on large scale or outsource
     Seller side – monopoly/oligopoly
     Buyer side – monopsony/oligopsony
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
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
EXPENSES FOR TWO PRODUCTS


    Organization     Output   Labor Printing Ink etc. Total
                                       Press          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                                    $30,400
    Combined production
     Two papers      100,000$10,000 $3,500 $13,400 $26,900
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
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
OPPORTUNITY COST

 definition -- net revenue from best alternative
  course of action
 two approaches

     •   show alternatives
     •   report opportunity costs
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.
    INCOME STATEMENT
SHOWING ALTERNATIVES
                     Continue
                    Warehouse        Shutdown
                    Operations
    Revenue          $700,000        $560,000
    Expenses         $220,000           $0
      Profit         $480,000        $560,000

 Income statement reporting opportunity costs
         Revenue         $700,000
           Cost          $780,000
           Profit        ($80,000)
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.
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.
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?
INCOME STATEMENT SHOWING
ALTERNATIVES
                              Continue        Cancel
                           Product Launch     Launch
     Contribution margin      $300,000          $0
         Graphic arts          $50,000        $50,000
        consultant fee
     Road Runner charge        $60,000        $30,000
      Daily Globe charge      $200,000        $20,000
             Profit           ($10,000)      ($100,000)

  Income statement omitting sunk costs
           Contribution margin            $300,000
             Graphic arts cost               $0
           Road Runner charge             $30,000
            Daily Globe charge            $180,000
                   Profit                 $90,000

				
DOCUMENT INFO