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The theory and estimation of costs

17 important questions on The theory and estimation of costs

Why do firms need to cut costs?

There is fierce competition

Increased with globalisation

Great need for efficiency

4+7 most common practices for reducing costs

Reduce nr of people on payroll

Consolidation of shared services among businesses

Outsourcing

Mergers and consolidation

strategic use of cost

reduction material cost

use information technology to reduce cost

reduction and relocation process costs

mergers, consolidation, subsequent downsizing

layoffs and plant closings

reduction in fixed assets

Difference between production function and cost function

product function is expressed in physical units

cost function is expressed in monetary

Q TVC TC MC AFC AVC

quantity, total variable costs, total cost, marginal cost, average fixed cost, average variable cost

7 assumptions in specifying a model of short-run cost function

firm:

1 employs two inputs: labor and capital

2 operates in short run period, labor variable input, capital fixed input

3 uses inputs to make single product

4 operates at given level of technology

5 operates at every level of output in the most efficient way

6 operates in perfectly competitive input markets, therefore pay for inputs at given market rate

7 his underlying short-run production is affected by the law of diminishing return

Marginal cost function:

MC= ^TQ/^Q

Relation between marginal product and marginal cost of production

WHen the firm's marginal product is decreasing, its marginal cost is increasing; when firm's marginal product is increasing, its marginal cost is increasing

Marginal product MP: def and formula

change in output of(total product) resulting from a unit change in a variable input.. MP=^Q/^X

Average product AP: def and formula

total product per unit of input used. APx=Q/X

Stage 1, stage 2 and stage 3 of production function in short run

stage 1: underutilizing fixed capacity, so still can increase output per unit by increasing amount of variable input

Stage 3: firm uses more variable inputs to produce less output

Relation MC and AVC in both short and long run and conclusion

If MC < AVC, then AVC is falling

If MC > AVC, then AVC is rising

If MC = AVC, then AVC is flat

Productivity and cost are inversely related,

In general, MC pulls AVC up or down depending if it is above or below average

What kind of shape of AC in long run?

U shaped

What is lowest point in srac?

firms maximum capacity

Maximum plant capacity?

level of output that costs a firm least amount per unit to produce in the short run

Learning curve? direction slope?

line showing relationship between labor cost and additional unit of output. In practise shows that workers improve with practise (Yx=Kx^n)

so with downward slope

Minimum efficient scale

smallest output when minimum lrac is achieved

How to reduce costs? lecture slides

Supply chain management (SCM):

efforts by a firm to improve efficiencies through each link of a firm’s supply chain from supplier to customer; goal – increase profits by reducing costs

outsourcing versus performing the activity inside the firm

“make versus buy decision” – the topic of TCE lecture

Reduction in cost of materials

Material substitution or modification (less, cheaper, lighter) – innovations in technology

E.g., Boeing 787 Dreamliner – lightweigt composite materials

Information technologies (IT)

E.g., ERP (enterprise resource planning) –

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The question on the page originate from the summary of the following study material:

International management | 9781849590556 | comp S W Douma

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The theory and estimation of costs

17 important questions on The theory and estimation of costs

Why do firms need to cut costs?

4+7 most common practices for reducing costs

Difference between production function and cost function

Q TVC TC MC AFC AVC

7 assumptions in specifying a model of short-run cost function

Marginal cost function:

Relation between marginal product and marginal cost of production

Marginal product MP: def and formula

Average product AP: def and formula

Stage 1, stage 2 and stage 3 of production function in short run

Relation MC and AVC in both short and long run and conclusion

What kind of shape of AC in long run?

What is lowest point in srac?

Maximum plant capacity?

Learning curve? direction slope?

Minimum efficient scale

How to reduce costs? lecture slides

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