Lecture 5 - Costs Objectives In this lecture, look for the...

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Costs
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Objectives In this lecture, look for the answers to these questions: Which costs matter? What are the determinants of short-run and long-run costs? What is the relationship between short-run and long-run costs? What is the learning Curve?
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1. Measuring Costs: Which Costs Matter? Economic Cost versus Accounting Cost accounting cost: Actual expenses plus depreciation charges for capital equipment. economic cost: Cost to a firm of utilizing economic resources in production, including opportunity cost. Opportunity Cost opportunity cost: Cost associated with opportunities that are forgone when a firm’s resources are not put to their best alternative use.
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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.
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The Northwestern University Law School has been located in Chicago. However, the main campus is located in the suburb of Evanston. In the mid-1970s, the law school began planning the construction of a new building and needed to decide on an appropriate location. Should it be built on the current site, near downtown Chicago law firms? Should it be moved to Evanston, physically integrated with the rest of the university? Some argued it was cost-effective to locate the new building in the city because the university already owned the land. Land would have to be purchased in Evanston if the building were to be built there. Does this argument make economic sense? No. It makes the common mistake of failing to appreciate opportunity costs. From an economic point of view, it is very expensive to locate downtown because the property could have been sold for enough money to buy the Evanston land with substantial funds left over. Northwestern decided to keep the law school in Chicago. Example 1   Choosing the Location for a New Law School Building
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Fixed Costs and Variable Costs total cost (TC or C) : Total economic cost of production, consisting of fixed and variable costs. fixed cost (FC): Cost that does not vary with the level of output and that can be eliminated only by shutting down. variable cost (VC): Cost that varies as output varies. The only way that a firm can eliminate its fixed costs is by shutting down.
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Example 2 It is important to understand the characteristics of production costs and to be able to identify which costs are fixed, which are variable, and which are sunk. Good examples include the personal computer industry (where most costs are variable), the computer software industry (where most costs are sunk), and the pizzeria business (where most costs are fixed). Because computers are very similar, competition is intense, and profitability depends on the ability to keep costs down. Most important are the variable cost of components and labor. A software firm will spend a large amount of money to develop a new application.
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Lecture 5 - Costs Objectives In this lecture, look for the...

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