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The Nature of Costs Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk Costs are Irrelevant

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The Nature of Costs. Explicit Costs Accounting Costs Economic Costs Implicit Costs Alternative or Opportunity Costs Relevant Costs Incremental Costs Sunk Costs are Irrelevant. Short-Run Cost Functions. Total Cost = TC = f(Q) Total Fixed Cost = TFC Total Variable Cost = TVC - PowerPoint PPT Presentation

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Page 1: The Nature of Costs

The Nature of CostsExplicit Costs

Accounting CostsEconomic Costs

Implicit CostsAlternative or Opportunity Costs

Relevant CostsIncremental CostsSunk Costs are Irrelevant

Page 2: The Nature of Costs

Short-Run Cost FunctionsTotal Cost = TC = f(Q)

Total Fixed Cost = TFC

Total Variable Cost = TVC

TC = TFC + TVC

Page 3: The Nature of Costs

Short-Run Cost FunctionsAverage 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

Page 4: The Nature of Costs

Short-Run Cost Functions

Q TFC TVC TC AFC AVC ATC MC0 $60 $0 $60 - - - -1 60 20 80 $60 $20 $80 $202 60 30 90 30 15 45 103 60 45 105 20 15 35 154 60 80 140 15 20 35 355 60 135 195 12 27 39 55

Page 5: The Nature of Costs
Page 6: The Nature of Costs

Short-Run Cost FunctionsAverage Variable Cost

AVC = TVC/Q = w/APL

Marginal Cost

TC/Q = TVC/Q = w/MPL

Page 7: The Nature of Costs

Long-Run Cost CurvesLong-Run Total Cost = LTC = f(Q)

Long-Run Average Cost = LAC = LTC/Q

Long-Run Marginal Cost = LMC = LTC/Q

Page 8: The Nature of Costs

Derivation of Long-Run Cost Curves

Page 9: The Nature of Costs

Relationship Between Long-Run and Short-Run Average Cost Curves

Page 10: The Nature of Costs

Possible Shapes ofthe LAC Curve

Page 11: The Nature of Costs

Learning CurvesAverage Cost of Unit Q = C = aQb

Estimation Form: log C = log a + b Log Q

Page 12: The Nature of Costs

Minimizing Costs InternationallyForeign Sourcing of InputsNew International Economies of ScaleImmigration of Skilled LaborBrain Drain

Page 13: The Nature of Costs

Cost-Volume-Profit AnalysisTotal Revenue = TR = (P)(Q)

Total Cost = TC = TFC + (AVC)(Q)

Breakeven Volume TR = TC

(P)(Q) = TFC + (AVC)(Q)

QBE = TFC/(P - AVC)

Page 14: The Nature of Costs

Cost-Volume-Profit AnalysisP = 40

TFC = 200

AVC = 5

QBE = 40

Page 15: The Nature of Costs

Operating LeverageOperating Leverage = TFC/TVC

Degree of Operating Leverage = DOL

% ( )

% ( )

Q P AVCDOL

Q Q P AVC TFC

Page 16: The Nature of Costs

Operating LeverageTC’ has a higher DOL than TC and therefore a higher QBE


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