CHAPTER 7 - COST ANALYSIS
Profit maximizing decisions depend on accurate estimates and projections of costs.
would be the cost of increasing production by X%, what is the impact on production costs if input costs
increase by X%, what production changes will reduce costs, etc.
These examples illustrate the important role that cost analysis plays in managerial decisions, and how
costs affect profits, etc. We consider several issues related to COSTS:
The only factors to consider are always the
relevant costs and the relevant benefits
, which are the
costs and benefits of alternative courses of action.
Opportunity Cost (OC)
one of the relevant costs for decision making. OC is defined as the benefits foregone in
the next highest valued alternative. For example, if you are making an exclusive choice between A and
B (movies, jobs, vacations, majors, etc.), the OC of choosing A (B) is B (A).
1. What is the OC of getting an MBA degree?
a. Explicit, Monetary cost:
b. Implicit OC (foregone benefit):
2. What is the OC of using excess factory capacity to supply specialty orders?
What is the foregone benefit of using the factory to supply specialty orders?
3. What is the OC of city-owned land that will be used as the site for a downtown parking garage?
Application of using OC for optimal decision making: Pursue activities ONLY when the incremental
(marginal) benefits exceed the incremental (marginal) costs. Applies to individuals, households,
organizations, governmental units, etc. Pursue an MBA ONLY if the MB > MC (including OC).
Problem: Check Station 1 on p. 255.
Economic Profit vs. Accounting Profit
Accounting profit = TR - TC (explicit, accounting costs) = NIAT (after-tax profits, earnings). Most of
the time, when the word "profit" is used, we are referring to accounting profits (NIAT). Accounting
profits are important to managers, shareholders, govt. (for taxes), etc. However, managerial decisions
should not be based only on accounting profits, but should always include the more comprehensive
ECN 469: Managerial Economics
Professor Mark J. Perry