Ec100A Ch7 - 7 COST Econ 100A Mortimer MEASURING COST:...

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COST 7 Econ 100A Mortimer
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MEASURING COST: WHICH COSTS MATTER? Economic Cost versus Accounting Cost accounting cost Actual expenses plus depreciation charges for capital equipment (based on the allowable tax treatment by the IRS) – retrospective/historical economic cost Cost to a firm of utilizing economic resources in production, including opportunity cost - prospective opportunity cost Cost associated with opportunities that are forgone when a firm’s resources are not put to their best alternative use important for economic decisions. e.g., the opportunity cost of inputs is the current market price of the inputs. Econ 100A Mortimer
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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 firm’s decisions. e.g., Consider the purchase of specialized equipment for a plant. Suppose the equipment can be used to do only what it was originally designed for and cannot be converted for alternative use. The expenditure on this equipment is a sunk cost. Because it has no alternative use, its opportunity cost is zero . e.g., You paid $10 to see a movie. Ten minutes into the movie, it is clear to you that the movie is horrible. Should you leave? - Note that $10 is a sunk cost. The relevant cost is whether you could more valuably spend your time doing something else. Econ 100A Mortimer
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MEASURING COST: WHICH COSTS MATTER? Example: Economic Cost Suppose you have started a snack food delivery business on campus. Students send you orders for snacks via the Internet. You shop at Costco to fill these orders and deliver the orders. To operate this business, you pay: • $500 a month to lease computer time from a local Web-hosting company to maintain your Web site; • $300 a month for your SUV that you use for your delivery; • $100 a month for insurance; and • $0.50 per order for gasoline. Say each order takes about a half hour and you could work at the campus dining hall for $6 an hour. Q1: What are your accounting costs and what are your economic costs? Solution: Your accounting costs would include all of the explicit costs incurred in the past, such as your car payment ($300), insurance ($100), leasing computer time ($500), gasoline ($.50 per order), and the cost of groceries. Your economic costs would include all of these explicit costs plus the opportunity cost of your time - $6 per hour. Econ 100A Mortimer
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MEASURING COST: WHICH COSTS MATTER? Example: Economic Cost Q2: Last week you purchased 5 large cases of Cheetos for a customer, who as it turned out, did no accept delivery. You spent $100 for the Cheetos but you can return to Costco for $0.25 for each dollar you spent. This week, you found a fraternity that is willing to pick up the 5 cases from your apartment for $55. What is the opportunity cost of filling this order? Solution:
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This note was uploaded on 04/24/2009 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at Berkeley.

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Ec100A Ch7 - 7 COST Econ 100A Mortimer MEASURING COST:...

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