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ch07 ppt notes

# ch07 ppt notes - Chapter Seven Costs and Cost Minimization...

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1 Costs and Cost Minimization Chapter Seven Chapter Seven

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2 Chapter Seven Overview 1. Introduction: Burke Mills 1. What are Costs? 1. Long Run Cost Minimization The constraint minimization problem Comparative statics Input demands 1. Short Run Cost Minimization Chapter Seven
3 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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4 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
5 (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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6 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
7 Backflush if opportunity cost of holding chips rises 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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8 Sunk Costs are costs that must be incurred no matter what the decision. These costs are not part of opportunity costs.
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