7 Cost - 7 COST Econ 100A Mortimer 1 MEASURING COST WHICH...

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COST 7 Econ 100A Mortimer 9/21/2009 1
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MEASURING COST: WHICH COSTS MATTER? Economic Cost versus Accounting Cost accounting cost Actual expenses plus depreciation charges for capital equipment – retrospective economic cost Cost of utilizing economic resources in production - prospective opportunity cost Value of the next best alternative that is forgone when another alternative is chosen . Econ 100A Mortimer 9/21/2009 2
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MEASURING COST: WHICH COSTS MATTER? Economic versus Accounting Cost Econ 100A Mortimer 9/21/2009 3 Ford spent $1 million 6 months ago for sheet steel that can be used to manufacture cars . It can also resell the steel to other firms. Suppose that the price of sheet steel has gone up and it is now worth $1.2 million. What is the accounting cost of the sheet metal? What is the opportunity cost of the sheet metal? What was the opportunity cost of the sheet metal when Ford considered buying it 6 months ago?
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MEASURING COST: WHICH COSTS MATTER? Sunk Costs Expenditure that has been made and cannot be recovered. → It should not influence the firm’s decisions. e.g., You spent $100,000 for specialized equipment for a plant that can be used to do only what it was originally designed for and cannot be converted for alternative use. Is this sunk? 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? Econ 100A Mortimer 9/21/2009 4
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MEASURING COST: WHICH COSTS MATTER? Fixed Costs and Variable Costs total cost (TC or C) Total economic cost of production; fixed costs + variable costs. fixed cost (FC) Cost that does not vary with the level of output and that can be eliminated only by shutting down. e.g., cost of plant maintenance, insurance, electricity. variable cost (VC) Cost that varies as output varies. e.g., wages, raw material costs Econ 100A Mortimer 9/21/2009 5
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MEASURING COST: WHICH COSTS MATTER? Fixed Costs and Variable Costs Fixed or variable? It depends on a time horizon. Over a very short time horizon —say, a few months—most costs are fixed. Over a very long time horizon—say, ten years—nearly all costs are variable . Econ 100A Mortimer 9/21/2009 6
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MEASURING COST: WHICH COSTS MATTER? Fixed and Sunk Costs Fixed costs can be avoided if the firm shuts down a plant or goes out of business. They affect decisions looking forward. Sunk costs are costs that have been incurred and cannot be recovered . They do not affect economic decisions. e.g., The cost of R&D to a pharmaceutical company to develop and test a new drug is sunk ex-post . But before it is spent, it is an investment and not sunk. Econ 100A Mortimer 9/21/2009 7
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Cost Minimization Step 1: Define the costs of inputs Step 2: Consider combinations of inputs that have the same total cost Step 3: Consider combinations of inputs that are needed for the same level of output Step 4: Find a cost-minimizing solution. Econ 100A Mortimer
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This note was uploaded on 10/26/2009 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at Berkeley.

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7 Cost - 7 COST Econ 100A Mortimer 1 MEASURING COST WHICH...

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