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Cost mms 10

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    • 1. Cost behavior
    • 2. Cost analysis
      • Types of costs:-
      • Behavior of cost in the short run
      • Behavior of cost in the long run
      • Economies of scale Vs Economies of scope
    • 3. Costs in the Short run
      • Fixed costs and variable costs
      • Total costs
        • total fixed cost ( TFC )
        • total variable cost ( TVC )
        • total cost ( TC = TFC + TVC )
    • 4. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12
    • 5. Total costs for firm X TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12
    • 6. Total costs for firm X TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91
    • 7. Total costs for firm X TVC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TFC
    • 8. Total costs for firm X TVC TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103
    • 9. Total costs for firm X TC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TVC TFC
    • 10. Total costs for firm X TC TVC TFC Costs start increasing at an increasing rate here
    • 11. Costs in the Short run
      • Average cost
        • average fixed cost ( AFC )
        • average variable cost ( AVC )
        • average (total) cost ( AC )
      • Relationship between average and marginal cost
    • 12. Average and marginal costs Output ( Q ) Costs (£) MC x
    • 13. Average and marginal costs Output ( Q ) Costs (£) MC x Diminishing marginal returns set in here
    • 14. Average and marginal costs Output ( Q ) Costs (£) AFC AVC MC x AC z y
    • 15. Marginal Costs
      • MC depends only on variable costs
      • Shows cost impact of change in production – fixed costs have no relevance to cost consequence of output change.
    • 16. Marginal Costs
      • MC is change in total cost as result of one unit change in output, TC(N) - TC(N-1)
      • Rate of change of total cost with respect to output:
      • MC=  TC/  N
      •  FC/  N +  VC(N)/  N
      •  VC(N)/  N
    • 17. What is the relationship between average and marginal costs? If MC < AC, then AC is falling If MC > AC, then AC is rising If MC = AC, then AC is constant
    • 18. COST BEHAVIOR LONG RUN COSTS
    • 19. Deriving long-run average cost curves: factories of fixed size Costs Output O 3 factories 2 factories 1 factory SRAC 3 SRAC 4 SRAC 5 5 factories 4 factories SRAC 1 SRAC 2
    • 20. Deriving long-run average cost curves: factories of fixed size SRAC 1 SRAC 3 SRAC 2 SRAC 4 SRAC 5 LRAC Costs Output O
    • 21. Deriving a long-run average cost curve: choice of factory size Costs Output O Examples of short-run average cost curves
    • 22. Deriving a long-run average cost curve: choice of factory size LRAC Costs Output O
    • 23. Economies of Scale
      • The advantages of large scale production that result in lower unit (average) costs (cost per unit)
      • AC = TC / Q
      • Economies of scale – spreads total costs over a greater range of output
    • 24. Economies of Scale (internal)
      • Internal – Advantages that arise as a result of the growth of the firm
        • Technical
        • Commercial
        • Financial
        • Managerial
        • Risk Bearing
    • 25. Economies of Scale
      • Internal: Technical
        • Specialisation – large organisations can employ specialised labour
        • Indivisibility of plant – machines can’t be broken down to do smaller jobs!
        • Increased dimensions – bigger containers can reduce average cost
    • 26. Economies of Scale
      • Indivisibility of Plant:
      • Not viable to produce products like oil, chemicals on small scale – need large amounts of capital
      • Agriculture – machinery appropriate for large scale work – combines, etc.
    • 27. Economies of Scale
      • Commercial
      • Large firms can negotiate favourable prices as a result of buying in bulk
    • 28. Economies of Scale
      • Financial
      • Large firms able to negotiate cheaper finance deals
      • Large firms able to be more flexible about finance – share options, rights issues, etc.
    • 29. Economies of Scale
      • Managerial
        • Use of specialists – accountants, marketing, lawyers, production, human resources, etc.
    • 30. Economies of Scale
      • Risk Bearing
        • Markets across regions/countries
        • Product ranges
        • R&D
    • 31. Economies of Scale (external)
      • External economies of scale :–
      • The advantages firms can gain as a result of the growth of the industry – normally associated with a particular area
      • Supply of skilled labour
      • Local knowledge and skills
      • Infrastructure
      • Training facilities
    • 32. Diseconomies of Scale
      • The disadvantages of large scale production that can lead to increasing average costs
        • Problems of management
        • Maintaining effective communication
        • Co-ordinating activities – often across the globe!
        • De-motivation and alienation of staff
        • Divorce of ownership and control
    • 33. More concepts :-
      • Stigler’s survivorship technique
      • Economies of scope:-

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