Theory of cost in managerial economics. MANAGERIAL THEORIES OF THE FIRM 2019-01-05
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Managerial Economics Theory of Production
It means when output is zero, variable costs are also zero. They also arise to firms in an industry from reductions in factor prices. As production is increased after this point, the average total costs rise quickly because the fall in average fixed costs is negligible in relation to the rising average variable costs. In the beginning they rise quickly, and then they slow down as the firm enjoys economies of large scale production with further increases in output and later on due to diseconomies of production, the variable costs start rising rapidly. The Traditional Theory of Costs: The traditional theory of costs analyses the behaviour of cost curves in the short run and the long run and arrives at the conclusion that both the short run and the long run curves are U-shaped but the long-run cost curves are flatter than the short-run cost curves. Most production takes place in business firms.
Managerial Economics: 6 Basic Principles of Managerial Economics
But after a minimum point, average variable cost stops falling but not the average cost. It is the opportunity missed or alternative forgone in having one thing rather than the other or in putting a factor-service to one use instead of the other. The other possible aims might be sales revenue maximisation or growth. The relationship has been shown in diagram 4. In , which may be defined as a residual left after all contractual costs have been met, including the transfer costs of management insurable risks, depreciation and payment to shareholders, sufficient to maintain investment at its current level. Moreover, a firm earns losses when average cost is more than average revenue.
Cost Analysis : Information on cost is required for decision making purposes. It means, initially it falls and after reaching the minimum point it starts rising upwards. Walmart Supply Chain Example Walmart has a very sophisticated supply chain where managers have to make purchase decisions regarding thousands of suppliers and the decision variables vary per location. Suppose the production of one more unit costs Rs. Then the firm will have to decide whether to shut down or produce some output.
This is because even when no output is produced, the firm has to incur fixed costs. As total variable costs or total costs first fall and then rise, marginal cost also behaves in the same way. Thus, he foregoes his salary as a manager. Cost-Output Relation: The Cost-output relation is discussed in the traditional and modem theories of costs under the short-run and long-run cost analysis which are explained as under. On the other hand, unavoidable costs are the costs which do not vary with changes in the level of production, but they are unavoidable such as fixed costs. There are certain forces such as consumer attitudes, or government policies or international competitiveness which are external to and beyond the control of an individual firm which is basically a micro-unit. They are important for calculation of profit and loss account.
Puri, Economics of Development and Planning, Himalaya Publishing House, New Delhi, 2002. Williamson, 86 3 , pp. Let us assume a case in which the firm has 100 unit of labour at its disposal. Such forecasting is to be based on national and international developments — both in economics and politics. Similarly, for a producer this concept implies that resources be allocated in such a manner that the marginal product of the inputs is the same in all uses.
Hence, the concept of opportunity cost is useful in the determination of relative prices of various goods. Some of these are competing concerns, such as how environmental concerns could curtail production objectives. When the ownership of a corporation is stretched over millions and millions of shareholders who belong to diverse groups it is unlikely that they will take an active interest in the management of the company as long as their dividends are satisfactory. Total revenue is just equal to total cost. We can make predictions from theory that will hold in the real world even though the theoretical structure abstracts from many actual characteristics of the world.
Suppose a manager can earn Rs. Governments should try to obtain the maximum benefit for tax payers in spending their revenues; government agencies can measure their efficiency through cost-benefit analysis. Break-Even Point: At times the firm may not make any profit. Generally, there are few processes for producing any one commodity. When economic profits are made in the short run, more firms will enter the industry in the long run until all economic profits are driven down to zero that is, firms will be making only normal return or profits on their capital investment.
Take for instance, education which not only provides higher incomes and other satisfactions to the recipients but also more enlightened citizens to the society. When they are symmetrically informed, they will always agree to collaborate. Shutdown Costs and Abandonment Costs: Shutdown costs are the costs that are incurred in the case of a closure of plant operations. So, profit maximization is the primary goal and others are subsidiary goals. Managerial economics makes use of the concept of price elasticity of demand in order to numerically measure and quantify market sensitivity of demand, i. The units of output that a firm produces do not cost the same amount to the firm. It is helpful in making such short term and long term decisions as: which products and services to produce? Frictional Theory of Profits : According to this theory there exists a normal rate of profit which is a return on capital that must be paid to the owners of capital as a reward for saving and investment of their funds rather than to consume all their income or hoard them.
The empirical results on long-run costs conform the widespread existence of economies of scale due to technical progress in firms. The productivity of labour and capital can be satisfactorily measured by using various techniques introduced in managerial economics. If the law allows and the entrepreneur is able to get his new innovation e. The increase in costs may be due to the overtime operations of the old and less efficient plant leading to frequent breakdowns, wastage of raw materials, reduction in labour productivity and increase in labour cost due to overtime operations. Elasticity of Productivity: The output of a firm is determined by the various inputs used by it. The firm will, therefore, continue to produce within Q 1Q 2 reserve capacity of the plant, as shown in Figure 7.
