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1、CHAPTER 7 OUTLINE,7.1 Measuring Cost: Which Costs Matter?7.2 Cost in the Short Run7.3 Cost in the Long Run7.4 Long-Run versus Short-Run Cost Curves7.5 Production with Two OutputsEconomies of Scope7.6 Dynamic Changes in CostsThe Learning Curve7.7 Estimating and Predicting Cost,MEASURING COST: WHICH C
2、OSTS MATTER?,Economic Cost versus Accounting Cost,accounting cost Actual expenses plus depreciation charges for capital equipment.,economic cost Cost to a firm of utilizing economic resources in production, including opportunity cost.,Opportunity Cost,opportunity cost Cost associated with opportunit
3、ies that are forgone when a firms resources are not put to their best alternative use.,MEASURING COST: WHICH COSTS MATTER?,Sunk Costs,sunk cost Expenditure that has been made and cannot be recovered.,Because a sunk cost cannot be recovered, it should not influence the firms decisions.Because it has
4、no alternative use, its opportunity cost is zero.,The Northwestern University Law School has been located in Chicago. However, the main campus is located in the suburb of Evanston.In the mid-1970s, the law school began planning the construction of a new building and needed to decide on an appropriat
5、e location. Should it be built on the current site, near downtown Chicago law firms? Should it be moved to Evanston, physically integrated with the rest of the university?Some argued it was cost-effective to locate the new building in the city because the university already owned the land. Land woul
6、d have to be purchased in Evanston if the building were to be built there. Does this argument make economic sense?No. It makes the common mistake of failing to appreciate opportunity costs. From an economic point of view, it is very expensive to locate downtown because the property could have been s
7、old for enough money to buy the Evanston land with substantial funds left over. Northwestern decided to keep the law school in Chicago.,MEASURING COST: WHICH COSTS MATTER?,MEASURING COST: WHICH COSTS MATTER?,Fixed Costs and Variable Costs,total cost (TC or C) Total economic cost of production, consi
8、sting of fixed and variable costs.,fixed cost (FC) Cost that does not vary with the level of output and that can be eliminated only by shutting down.,variable cost (VC) Cost that varies as output varies.,The only way that a firm can eliminate its fixed costs is by shutting down.,MEASURING COST: WHIC
9、H COSTS MATTER?,Fixed Costs and Variable Costs,Shutting Down,Shutting down doesnt necessarily mean going out of business.By reducing the output of that factory to zero, the company could eliminate the costs of raw materials and much of the labor. The only way to eliminate fixed costs would be to clo
10、se the doors, turn off the electricity, and perhaps even sell off or scrap the machinery.,Fixed or Variable?,How do we know which costs are fixed and which are variable?Over a very short time horizonsay, a few monthsmost costs are fixed. Over such a short period, a firm is usually obligated to pay f
11、or contracted shipments of materials.Over a very long time horizonsay, ten yearsnearly all costs are variable. Workers and managers can be laid off (or employment can be reduced by attrition), and much of the machinery can be sold off or not replaced as it becomes obsolete and is scrapped.,MEASURING
12、 COST: WHICH COSTS MATTER?,Fixed versus Sunk Costs,Amortizing Sunk Costs,amortization Policy of treating a one-time expenditure as an annual cost spread out over some number of years.,Sunk costs are costs that have been incurred and cannot be recovered.An example is the cost of R&D to a pharmaceutic
13、al company to develop and test a new drug and then, if the drug has been proven to be safe and effective, the cost of marketing it. Whether the drug is a success or a failure, these costs cannot be recovered and thus are sunk.,MEASURING COST: WHICH COSTS MATTER?,It is important to understand the cha
14、racteristics of production costs and to be able to identify which costs are fixed, which are variable, and which are sunk.Good examples include the personal computer industry (where most costs are variable), the computer software industry (where most costs are sunk), and the pizzeria business (where
15、 most costs are fixed).Because computers are very similar, competition is intense, and profitability depends on the ability to keep costs down. Most important are the cost of components and labor.A software firm will spend a large amount of money to develop a new application. The company can recoup
16、its investment by selling as many copies of the program as possible.For the pizzeria, sunk costs are fairly low because equipment can be resold if the pizzeria goes out of business. Variable costs are lowmainly the ingredients for pizza and perhaps wages for a workers to produce and deliver pizzas.,MEASURING COST: WHICH COSTS MATTER?,Marginal and Average Cost,Marginal Cost (MC),marginal cost (MC) Increase in cost resulting from the production of one extra unit of output.,
