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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
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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
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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
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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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