This presentation gives an idea on 3 topics. cvp analysis, operating leverage and also the estimation of cost functions. hope the readers can make the best use of it.

1. MANAGERIAL ECONOMICS
CVP Analysis, Operating Leverage, Estimation of Cost Function

2. CVPANALYSIS
Also known as Break- Even Analysis. It is an analytical technique used by organization for decision making. It studies
the relationship between 3 variables i.e. Total Revenue, Total Cost and Total Profits of the firm at various levels of
output.
Assumptions:
• Constant selling price
• Constant factor prices
• Division of Fixed cost and Variable cost is possible
LEVEL OF
OUTPUT
REVENUE
PROFIT
COST

3. CVPANALYSIS
• TR= P(Q)
• TC= TFC+ (AVC)(Q)
• TR= TC
P(Q)- (AVC)(Q
B)= TFC
(Q
B)(P- AVC)= TFC
(Q
B)=
𝑇𝐹𝐶
𝑃−𝐴𝑉𝐶
• Q
r =
𝑇𝐹𝐶+π
r
𝑃−𝐴𝑉𝐶
• Π
r = TR- TC

4. OPERATING LEVERAGE
What is Leverage?
The word leverage is borrowed from Physics, it is used to describe the ability of a firm to use fixed cost assets or funds
to increase the returns.
Operating
Leverage
Financial
Leverage
Combined
Leverage

5. OPERATING LEVERAGE
What is Operating Leverage?
• is the ratio of a company’s fixed costs to its variable costs.
• A firm with relatively high fixed operating costs will experience more variable operating income if sales change.
DOL=
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑠𝑎𝑙𝑒𝑠

6. OPERATING LEVERAGE

7. ESTIMATING SHORT- RUN COST FUNCTIONS
• Empirical estimates of cost functions are essential for many managerial decision purposes.
• Knowledge of short run cost functions is necessary for the firm in determining the optimal level of output ad price
to charge.
• Whereas, the knowledge of long run cost functions is essential in planning for the optimal scale of plant for the firm
to build in the long run.

8. ESTIMATING SHORT- RUN COST FUNCTIONS
Data and Measurement
• The most common method of estimating the firm’s short run cost functions is regression analysis.
• Where the total variable cost are regressed against output and a few other variables, such as input prices and
operating conditions, during the time period when the size of the plant is fixed.
• The same sorts of regression techniques can be used to estimate short run cost functions and long run cost functions.
However, it is very difficult to find cases where the scale of a firm has changed but technology and other
relevant factors have remained constant.

9. FUNCTIONAL FORM OF SHORT- RUN COST FUNCTIONS
This economic theory postulates an S shaped (cubic) TVC curve, with corresponding U-Shaped AVC and MC curve
below:

10. ESTIMATING LONG-RUN COST FUNCTIONS WITH CROSS-
SECTIONAL REGRESSION ANALYSIS
Methods used for estimation:
• Regression Analysis using time-series data
• Regression Analysis using Cross-Sectional data
Estimating the long-run cost curves to determine the best scale of plant for
the firm to build in order to minimize the cost of producing the anticipated level of output
in the long run.

11. ESTIMATING LONG-RUN COST FUNCTIONS WITH CROSS-
SECTIONAL REGRESSION ANALYSIS
PLUSES:
• Since data comes from different firms, quantity of output can vary relatively wide ranges.
• All data from same point of time, so technology will not change.
• Do not have to worry regard price changes.
MINUSES:
• Interregional cost differences.
• All firms not necessarily operating at optimal level of technology.
• Costs may be recorded differently in different firms.
• Different companies may pay their cost factors differently.

12. ESTIMATING LONG-RUN COST FUNCTIONS WITH CROSS-
SECTIONAL REGRESSION ANALYSIS

13. ESTIMATING LONG-RUN COST FUNCTIONS WITH
ENGINEERING AND SURVIVAL TECHNIQUES
Knowledge of the physical relationship between inputs and output expressed by the production function to determine
the optimal input combination needed to produce various levels of output.
 Based on current data and technology
 Application – e.g. Petroleum refining & chemical production
 Merits & Demerits
Optimal
quantity of
each input
Price of
input
Long run
cost
function of
the firm

14. SURVIVAL TECHNIQUE
• John Stuart Mill & George Stigler
• Features
Eg: Application by Stigler on Steel Industry, Automobile Industry
Studying the cost by observing the survival
It is believed that –
• Large and small firms coexist in the
same industry, in the long run scale of
economies.
• Large firms have - larger share in the
market, wide range of output, lower
LAC, more efficient.
• Drive away small and less efficient
firms – only large firms in the long run.
Larger firms strive Economies of scale
Smaller firms
strive
Diseconomies of
scale

15. THANK YOU
NISHA JOHNSON 20SJCCM017
NITHIN KUMAR 20SJCCM018
PRAGATHI V 20SJCCM019
RANI AMULYA DALBY 20SJCCM020
REEN R 20SJCCM021