Ch7-slides - Chapter Seven Costs and Cost Minimization...

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Costs and Cost Minimization Chapter Seven Chapter Seven
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Chapter Seven Overview 1. Introduction 2. What are Costs? 3. Long Run Cost Minimization The constraint minimization problem Comparative statics Input demands 4. Short Run Cost Minimization 1. Introduction 2. What are Costs? 3. Long Run Cost Minimization The constraint minimization problem Comparative statics Input demands 4. Short Run Cost Minimization Chapter Seven
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What’s behind the self-service revolution? Self service in American retail landscape. • Self check-in • Self check out • Consumers have grown more comfortable with personal technologies: PC, cell phones, PDAs. • Firms lower their costs by substituting capital (self-checkout systems) for labor (cashiers).
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The relevant concept of cost is opportunity cost : the value of a resource in its best alternative use. The only alternative we consider is the best alternative The relevant concept of cost is opportunity cost : the value of a resource in its best alternative use. The only alternative we consider is the best alternative Chapter Seven Opportunity Cost
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Chapter Seven Example: Investing $50M - $50M to invest with four alternatives: 1.) If invest now in CD-ROM factory, expected revenues are $100M 2.) If wait a year, expected revenues from CD-ROM investment are 75M 3.) If build new technology plant now , 50% chance that revenues are $0, 50% chance yields $150M. 4.) If wait a year, will know whether revenues are $0 or $150M. Opportunity Cost
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(3) yields .5($0) + .5($150M) = $75M (4) yields .5($75M) + .5($150M)=$112.5M Chapter Seven What is the opportunity cost of investing in CD- ROM plant now ? Hence, (4) is the best alternative and the opportunity cost is $112.5M Costs depend on the decision being made Example: Opportunity Cost of Steel Purchase steel for $1M. Since then, price has gone up so that it is worth $1.2M Opportunity Cost
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What is the opportunity cost of manufacturing the cars? $1.2M Costs depend on the perspective we take • Opportunity costs often are implicit Chapter Seven Opportunity Cost 1) Manufacture 2000 automobiles 2) Resell the steel 1) Manufacture 2000 automobiles 2) Resell the steel
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Ö Backflush if opportunity cost of holding chips rises Ö Accounting costs may be lower or higher than economic costs Chapter Seven Opportunity Cost – DRAM Chips Both a long term and a spot market for DRAM chips exist Opportunity cost equals the current spot price, not the historical contract price
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To Smelt or Not to Smelt Kaiser Aluminum (Pacific North) purchased electricity from BPA. Long-term contract: $23 per megawatt hour. In late 2000 and early 2001, the spot market price of electricity in the region skyrocketed ($1000 per megawatt hour). High opportunity cost for Kaiser to operate its plants. It
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Ch7-slides - Chapter Seven Costs and Cost Minimization...

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