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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

25 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

25 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

25 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

25 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

25 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Outline

1 Class 1: Intro and Demand

2 Class 2: Costs Costs Definitions: Which Costs Matter? Costs: Structure Cost Structure: How and Why Costs Matter

3 Class 3: Competition

4 Class 4: Market Failure

5 Class 5: Information and Decisions

6 Class 6: Capstone Class

7 Class 7: Exams

25 / 125

Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Quiz 1

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Why are we in class today?

Producing stuff is costly

Customers do not like paying more than they need to

Firms need to know how their own costs behave

Knowing how costs behave can help decide how to price and when to shutdown

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Key Learning Objectives

Relevant costs - which costs are and which are not

Cost functions - elements of production costs

Returns to Scale

(Dis)Economies of Scope

Shutdown Rule

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs Definitions: Which Costs Matter?

Definitions

Costs that matter from an economic (and managerial!) perspective are not always measured in accounting statements

Important costs that are not measured: Opportunity costs

Measured accounting costs that are irrelevant for decision-making: Sunk costs

Marginal costs are often more relevant than average costs

Cost Examples

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs: Structure

Definition: Total Costs

Total cost: sum of all component costs related to a certain output level in a given period

includes opportunity costs of uncompensated production resources

e.g of uncompensated resources: owner’s time and a "normal" return on capital

does not use accounting estimates of depreciation

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs: Structure

Definition: Average Costs

Average cost = Total cost/quantity produced Class Example

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs: Structure

Definition: Marginal Costs

Marginal cost: cost of one additional unit of output = δTotal Cost δQuantity

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs: Structure

Class Exercises

TestBank

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs: Structure

Structure: Short Run Costs

In the short-run firms are unable to change the scale of the most significant inputs, e.g.

physical capital (number and size of plants, investment in equipment) knowledge capital (R&D, investment in specific production methods)

Short Run Costs - Class Exercises

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Costs: Structure

Structure: Long Run Costs

In the long-run firms can change the scale of all production inputs

all costs are ’avoidable’ in the long run

Definitions of long-run and short-run vary by industry

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Cost Structure: How and Why Costs Matter

Structure: Economies of Scale

Primary strategic question for most firms: how big to be? To merge or not to merge with competitor? To down-scale? To change production technology?

Answer usually depend on economies of scale, or changes to minimum efficient scale

Economies of scale: increasing Q decreases LRAC Constant returns to scale: increasing Q does not change LRAC Diseconomies of scale: increasing Q increases LRAC Minimum efficient scale: plant size that minimizes LRAC

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Cost Structure: How and Why Costs Matter

Structure: Economies of Scope

Another strategic question for most firms: what to make and what to buy? To undertake vertical mergers? To invest in upstream/downstream sector?

Answer usually depend on cost structure

Economies of scope are positive if C(q1, q2) < C(q1, 0) + C(q2, 0)

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Cost Structure: How and Why Costs Matter

Team Project Discussion

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Cost Structure: How and Why Costs Matter

Shutdown Rule

When should management discontinue a line of business?

When average costs exceed price? (AC > P) Not necessarily:

Product contribution: Revenue - Variable Costs Profits: Product Contribution - Fixed Costs

In short run, firms should continue production as long as price exceeds AVC

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Cost Structure: How and Why Costs Matter

Recap

Opportunity cost is the implicit ’pain’ cost associated with each choice

Sunk costs are expenditures that once made cannot be recovered

Total economic cost includes opportunity costs, and ignores sunk costs

Average cost is total economic cost divided by output

Marginal cost is the change in total economic cost for one additional unit of output

The shutdown rule: price < AV C

The short-run is the period within which firms can’t modify production scale

Many costs are therefore fixed in the short-run, for a given quantity.

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Class 1: Intro and Demand Class 2: Costs Class 3: Competition Class 4: Market Failure Class 5: Information and Decisions Class 6: Capstone Class Class 7: Exams

Cost Structure: How and Why Costs Matter

Prep for Next Class

We will discuss competition

Read the selected pages in Chapter 9 before class, there will be a quiz

Revise today’s material, work with your group to outline team report

...Submit updated team report

Take some time to breathe and relax, it will all be fine

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