Lecture Managerial economics - Chapter 3 presents content: Inputs, outputs, and decisions; outputs, inputs, and business firms; economic cost concept; two types of management problems; cost structure; managerial accounting;... Inviting you to refer.
PRODUCTION, COSTS AND SUPPLY Inputs, Outputs, and Decisions TYPICAL ORGANIZATION CHART OF A FIRM PRODUCTION Production is the act of transforming resources into goods and services that are more valuable For example, oil is extracted from the ground, refined into gasoline, and used as transportation fuel A hair stylist uses time, scissors, and chemicals to make a customer feel more attractive and self-confident, which is potentially of great value for a job interview OUTPUTS, INPUTS, AND BUSINESS FIRMS A firm is an entity combines inputs to produce output A firm’s production function is the relationship between it’s inputs and output OUTPUTS, INPUTS, AND BUSINESS FIRMS For every bundle of inputs the production function shows the maximum output that can be produced Here we assume that all inputs are the same within their classification; i.e., all labor is homogeneous We also assume one person that makes all decisions on inputs and outputs and is the residual claimant (pockets the profits) There are no conflicts in this hypothetical world ECONOMIC COST CONCEPT Opportunity cost: next best alternative use • The real cost is what you give up to get it • In economics, all the costs are measured by opportunity cost • Opportunity cost includes explicit and implicit costs–includes time value of searching/waiting Example: opportunity cost might even help explain why higher earners spend less time asleep on average than those who make less TWO TYPES OF MANAGEMENT PROBLEMS Decision Making • Which product should we be producing? cost • How should we price our products? Opportunity matters • What strategy should we be pursuing? • Should we be in this business? Control • Are our managers performing well? Accounting cost matters • Are our businesses performing well? • How can we influence the behavior of our people? COST STRUCTURE Economic Cost Structure (Opportunity Costs) • Fixed Cost: Costs that not vary with quantity produced • Variable Cost: Cost that vary with quantity • Sunk Cost: Costs that cannot be avoided regardless of action Accounting Cost Structure (COGS) • Direct Cost: Labor and Materials • Indirect Cost: Overhead Cost – accountants sometimes call this as “fixed cost”, which is not fixed cost in economics » some overhead cost does vary with quantity (“avoidable”), NOT fixed » Ex Production supplies, tools, benefits vary with quantity In general, Accounting cost ≠ Economic cost MANAGERIAL ACCOUNTING For decision making problems, opportunity cost matters • But often in practice, opportunity costs are not given • Instead, you need to make business decisions based on financial statement which shows accounting costs How to translate the accounting cost into opportunity cost? Course of Managerial Accounting QUESTION: FIXED OR SUNK? Fixed cost • A past expenditure that can be recovered by reselling –ex: cost of equipment that may be recouped by equipment sale Sunk cost • A past expenditure that cannot be recovered –R&D investment in pharmaceutical companies •Principle: Let bygone be bygone • Sunk costs “should not” influence an individual’s or firm’s decisions –Why? DISCUSSION You bought a theater ticket for $15 a few weeks ago Bad news: • At the theater you find you left the ticket at your home and it’s too late to go back Good news: • But you can still buy a comparable ticket for $15 at the box office Q: Will you buy a new ticket & see the show? Q: Which is the rational decision? IS SUNK COST BAD FOR THE BUSINESS? Suppose you are running a business and found that you incurred a huge sunk cost in the previous quarter Q: Is this good or bad for your company? SUNK, FIXED, VARIABLE COST Discuss the cost structure for the following industries Computer Industry Software Industry Pizza Industry SUMMARY Principle: The real cost is what you give up to get it • Economic cost is the opportunity cost Opportunity cost matters for decision making, accounting cost matters for control purpose Principle: Let bygone be bygone • Don’t consider the sunk cost when making decision SUPPLY CURVE SUPPLY CURVE Supply curve = Marginal Cost curve When does the supply curve shift? Producer Surplus SUPPLY CURVE = MARGINAL COST CURVE • In a competitive market, where you can’t change the price Supply curve = (Marginal) cost curve Implications? • If anything happens to the cost, the supply curve changes (shifts) SUPPLY CURVE SHAPE Q: COST INCREASE = PRICE INCREASE? SUPPLY CURVE “SHIFTERS” IMPACTS ON SUPPLY ARISING FROM CHANGES IN SUPPLY DETERMINANTS PRODUCER SURPLUS SUMMARY Marginal cost curve is supply curve Supply curve shifters: Change in cost ... consider the sunk cost when making decision SUPPLY CURVE SUPPLY CURVE Supply curve = Marginal Cost curve When does the supply curve shift? Producer Surplus SUPPLY CURVE = MARGINAL COST CURVE •... real cost is what you give up to get it • In economics, all the costs are measured by opportunity cost • Opportunity cost includes explicit and implicit costs includes time value of searching/waiting... the price Supply curve = (Marginal) cost curve Implications? • If anything happens to the cost, the supply curve changes (shifts) SUPPLY CURVE SHAPE Q: COST INCREASE = PRICE INCREASE? SUPPLY CURVE