Lecture Managerial economics - Chapter 3: Production, costs and supply

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