Costs: Variable, Average and Marginal
Costs: Variable, Average and Marginal
Costs: Variable, Average and Marginal
First distinction:
– corporate HQ costs.
Variable Costs
Depend in some way on production levels
within the organization
examples:
– materials
– power
Note that the line between fixed and
guide case.
TC = total cost, VC = variable cost, AC =
TC = FC + VC
proportionally? Less?
Variable cost proportional to output
Average
cost Large firms have cost
FC/N + advantage over smaller
ones.
Output
Cost curves & Mergers
Falling average costs can provide impetus
for mergers
Compaq-Hewlett Packard merger may be of
this type, as were mergers of Chase and
Chemical Bank.
Other motives may be in terms of product
complementarity.
Variable costs quadratic in
output:
VC(N) = N + N2
Then AC = FC/N + + N
Average
cost
FC/N +N
Output
Next Distinction
Average
cost
FC/N +
Marginal cost
Output
What is the relationship between
average and marginal costs?
A
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Dynamic Changes in
Costs--The Learning Curve
Hours of labor
The horizontal axis per machine lot
measures the
cumulative number of
10
hours of machine tools
the firm has produced 8
0 10 20 30 40 50
Dynamic Changes in
Costs--The Learning Curve
Observations
Cost
($ per unit
of output)
Economies of Scale –
reversible.
A
B
AC1
Learning
C AC2
Output
Dynamic Changes in
Costs--The Learning Curve
P(N) . N = FC + VC(N)
Total Cost = FC + VC(N) = FC + bN + c N2
MC = n + 2cN
Price
MC
Output
Breakeven
Leverage
E ,Q = / Q
=
Q/Q Q
This is the ratio of the proportional change in
profits resulting from an output change to the
Pulse para añadir texto
proportional change in output causing it. If
this number is 5, for example, it tells us that a
1% change in output leads to a 5% change in
profits
Profit
= PQ(revenue) - TC(total cost)
= PQ - FC - VC
Elasticity of with respect to Q:
E,Q = (d/dQ)(Q/)
d/dQ =Pulse
P - (dVC/dQ) = P - MC
para añadir texto
E,Q = P-MC(Q/)
P - MC = contribution to overhead or
contribution margin
/Q = (PQ - AC*Q)/Q so
(Q/) = 1/(P - AC) so
E,Q = P-MC/P-AC
“Operating leverage”
MC = AC: E,Qpara
Pulse = 1 añadir texto
MC < AC: E,Q > 1
0.00
10 20 30 40 50 60 70 80 90 100
Sales, millions
Microsoft needed to sell 65 million units @ $35 to
recover its fixed investment in the development
and promotion of Windows.
AC = TC/Q = 1 + 2.3B
Q
Compute operating leverage using
formula E,Q = P - MC
P-AC
E,Q = 35
35 - 2.3B
Pulse Q para añadir texto
Multiply numerator and denominator by Q/35
Q
Q - 65M
Near the breakeven point, small fluctuations in
output induce large fluctuations in profits.
If output expands to Q
Pulse = 90añadir
para million copies, then
texto
operating leverage is 3.7
A given fluctuation in sales induces a smaller
proportionate increase in profits.
Cost Allocation
Delivery @ $0.013/copy
Circulation = 48,000
Printing costs:
Cover = 4 pages
Story = 16 pages
Program = 48 pages
Printing delivery and binding costs will be same as
in Culver City, = $0.144/copy
Plates:
Cover page plates 4 @ $405 = $1620
Story book plates 16 @ $405 = $6480
Program book plates 48 @$108 = $5184
Makes total annual set up costs = $13,200 per
year. To express this per copy divide by
52x48,000 making $0.0053 a copy. Total
weekly setup costs are $13,284. Per copy this
is $0.276