Appendix 7C
Steve:
Phil:
Steve:
Phil:
Steve:
Interview with a Supply Chain Management Executive
Yes, thanks to intense competition from
companies who competed solely on price
(rather than brand or differentiation),
the day of the 40 to 50 percent gross
pr

Chapter 7
Table 7.3
The Theory and Estimation of Cost
261
Long-Run Cost Function
Scale of
Production
(Capacity Level)
Total Product
(Output/Mo)
Long-Run
Total Cost
(LRTC)
Long-Run
Marginal Cost
(LRMC)
Long-Run
Average Cost
(LRAC)
A
B
C
D
E
F
10,000
20,000

264
Chapter 7
The Theory and Estimation of Cost
$/Q
LRAC
Minimum
LRAC line
Economies of scale
IRTS
Figure 7.8
Efficient scale
CRTS
MinES
Diseconomies of scale
DRTS
MaxES
Q
Long-Run Average Cost
marginal cost begins to rise. Eventually it becomes greater t

Appendix 7A
A Mathematical Restatement of the Short-Run Cost Function
293
Excel Sheet 7A.1
A
B
C
D
TC=a+bQcQ2+dQ3
1
84700 a = FC
2
Cubic TC
1000 b = linear term
3
15 c = quadratic term
Equation
(7A.2)
4
0.1 d = cubic term
coefficients bank (Equation refer

282
Chapter 7
The Theory and Estimation of Cost
SUMMARY
This chapter is devoted to the analysis of the cost structure of the firm, both in the short run
and the long run. In the short-run analysis, it is important to keep in mind that behind the
scenes, t

A p p e n d i x
7 B
The Estimation of Cost
Learning Objectives
Upon completion of this appendix, readers should be able to:
Describe the use of time series regression
Consider the question: Are there econoanalysis in measuring short-run costs, evalumies

302
Appendix 7B
The Estimation of Cost
over a fairly wide range. The largest banks begin to
face diseconomies.44
Dairy Farms A recent study, using data from
2000, estimates returns to scale across U.S. dairy
farms of different sizes and over different reg

272
Chapter 7
The Theory and Estimation of Cost
$/Q
Current
loss
Price
Future profit
(learning curve)
LRAC
"Today's"
production
Figure 7.14
"Tomorrow's"
production
Q (cumulative
over time)
Pricing Based on Learning or Experience Curve
In concluding this s

Appendix 7B
increasing marginal and average costs. The cubic
total cost function is31:
TC ! a " bQ # cQ 2 " dQ 3
When estimating this equation, the analyst is not required to manually insert the # sign in the model.
The regression analysis will simply est

Chapter 7
The Theory and Estimation of Cost
277
Raw materials savings
"206" can with
reduced lid
Figure 7.16
"209" can with
normal size lid
Using Reduced-Lid Can to Achieve Raw Materials Savings
Over the years, Southwest Airlines low-cost approach continu

280
Chapter 7
The Theory and Estimation of Cost
but not so with consumers. They would much prefer to go to a store and try out a laptop for themselves. Furthermore, Dells models and designs were geared more toward
the office than the family room. When Del

Chapter 7
The Theory and Estimation of Cost
279
buying and managing fixed assets tends to be covered at a rather high level of abstraction. We simply treat it as part of the fixed cost of doing business. More specifically,
this fixed cost includes depreci

Chapter 7
Quadratic
Cubic
$
The Theory and Estimation of Cost
TC
TC = a + bQ cQ2+ dQ3
$
TC = a + bQ + cQ2
ACmin
259
Linear
TC
$
TC = a + bQ
TC
ACmin
Q
TFC
TFC
AVCmin
Q
Q
(c)
(a)
$/Q
TFC
AVCmin
$/Q
AVCmin ACmin MC
ACmin
(e)
MC
AC
AC
AVC
AVC
$/Q
AC
AVC = MC

Chapter 7
The Theory and Estimation of Cost
289
a. Plot this curve for quantities 1 through 15.
b. Calculate the average total cost, average variable cost, and marginal cost, and plot them
on another graph.
c. Discuss your results in terms of decreasing,

288
Chapter 7
The Theory and Estimation of Cost
a. Plot this curve for quantities 1 to 10.
b. Calculate the average total cost, average variable cost, and marginal cost for these quantities, and plot them on another graph.
c. Discuss your results in terms

Chapter 7
$/Q
The Theory and Estimation of Cost
269
Potential
cost inefficiency
a
Potential
cost inefficiency
b
c
5,000 10,000
20,000 25,000
Q
Figure 7.11 Unnecessary
Costs Due to Inappropriate
Plant Size
As a final comment on long-run cost, it is easy to

Chapter 7
The Theory and Estimation of Cost
275
postulated that a company compares the costs of organizing an activity internally with
the cost of using the market system for its transactions. The cost incurred by using resources outside was what he calle

Appendix 7C
Steve:
Phil:
Steve:
Phil:
Steve:
Phil:
Steve:
Interview with a Supply Chain Management Executive
us of the human dimension to all our
graphs and theory.
Thats one way to put it. In any event, one
of Compaqs major CMs was a company
called Flext

292
Appendix 7A
A Mathematical Restatement of the Short-Run Cost Function
Comparing Equations (7A.7) and (7A.8), we see
that Q M = (2>3)Q V. One can readily see that this
is true in the cubic per-unit cost figures in the chapter. One should note that find

Appendix 7B
for larger firm and plant size. However, a majority of
the empirically estimated functions suggest the existence of scale economies up to a point. As output increases to a substantial size, these economies rapidly
disappear and are replaced by

Chapter 7
The Theory and Estimation of Cost
257
declines, reaches a minimum at 4 units of output, and then starts to increase. Average
total cost (ATC or AC) behaves in a similar fashion but reaches its minimum point at
6 units of output. Marginal cost de

Chapter 7
APP
The Theory and Estimation of Cost
267
To understand the full economic implication of this observation, it is necessary to take
a slight detour in our discussion to explain the particular way in which economists
represent plant capacity with

260
Chapter 7
The Theory and Estimation of Cost
referring to total cost increasing at an increasing rate, we can simply say that the
firms marginal cost is increasing. An increase in total cost at a constant rate means a
constant marginal cost. We can als

300
Appendix 7B
The Estimation of Cost
introduced. Because the observations are taken from
plants (or firms) in different geographic areas, we
may encounter interregional cost differences in labor rates, utility bills, material costs, or transportation
co

296
Appendix 7B
The Estimation of Cost
reconcile these concepts, but certain corrections
can be made.
simultaneously, some weighting apparatus must be
employed to obtain the quantity produced.30
Changes in prices of labor, materials, and other inputs must

Appendix 7B
different results appeared. Most of the firms in the
former group were concentrated in the four lowersize categories and most firms in the latter group
were in the top four. When the nonbranch societies
and the branch societies were analyzed s

Chapter 7
The Theory and Estimation of Cost
271
For an 80 percent learning curve, the number of direct labor hours required to produce the eighth unit of output is
S = 0.8
Y8 = 100,000 # (8)log(0.8)>log2
= 100,000(8) -.322
100,000
=
8.322
100,000
=
= 51,2

A p p e n d i x
7 A
A Mathematical Restatement
of the Short-Run Cost Function
The general form of the short-run cost function is
TC = f(Q)
(7A.1)
where TC ! Total cost
Q ! Output
As stated in this chapter, three specific forms of this
function are used in

Chapter 7
of a project incurred up to the point at which a
decision is to be made). (p. 251)
Incremental cost. The total cost associated with a
particular decision (e.g., the cost of building an
additional wing to an office building, the cost of
going int

290
Chapter 7
The Theory and Estimation of Cost
16. Undertake a comparative statics analysis using the Cobb Douglas Costs Excel App file by filling in
the following table. Increase each parameter by 50 percent holding the other parameters at their
initial