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 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?

• How should we price our products?

• What strategy should we be pursuing?

• Should we be in this business?

Control

• Are our managers performing well?

• Are our businesses performing well?

• How can we influence the behavior of our

people?

Opportunity cost matters

Accounting cost matters

COST STRUCTURE

Economic Cost Structure (Opportunity

Costs)

• Fixed Cost: Costs that do not vary with quantity produced

• Variable Cost: Cost that do 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

QUESTION: FIXED OR SUNK?

• 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?

• 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

1 Computer Industry

2 Software Industry

3 Pizza Industry

1 Principle: The real cost is what you give up to

get it

• Economic cost is the opportunity cost

2 Opportunity cost matters for decision making,accounting cost matters for control purpose

3 Principle: Let bygone be bygone

• Don’t consider the sunk cost when making

decision

SUPPLY CURVE

 1 Supply curve = Marginal Cost curve

 2 When does the supply curve shift?

 3 Producer Surplus

SUPPLY CURVE

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”

I MPACTS ON S UPPLY A RISING FROM CHANGES IN S UPPLY

D ETERMINANTS

PRODUCER SURPLUS

1 Marginal cost curve is supply curve

2 Supply curve shifters: Change in cost