Presented by Athulya V Panicker Lekha R Devi Priya K R Shija Vijayakumar Suresh

Demand

estimation, forecasting demand & cost of production plays an essential role. Total cost together with total revenue determines profit level. Cost of production provides for managerial decision with respect to pricing. Cost function relation between cost and output. depends on production conditions and prices of factors used for production. Making of effective and right decisions depends on calculation of costs.

COST CONTAINMENT STRATEGIES

Restructuring Downsizing Rightsizing Redundancy Forced management Outsourcing Relocation of manufacturing facilities to low wage countries Deverticalisation Mergers Consolidation

DEFINITION & USE OF COSTECONOMIC ANALYSIS

GAAP (Generally Accepted Accounting Principles)as per ICAI(Institute of Chartered Accountants of India) used for corporate accounting. Definition of cost based on relevancy for internal analysis and decision making. Cost is considered to be relevant if it is affected by managerial decision; otherwise irrelevant.

RELEVANT & IRRELEVANT COST

Historical Vs Replacement cost Historical cost- price paid originally for cost of plant, equipment, materials-irrelevant Replacement cost-price that have to be paid currently for replacing or acquiring same asset-relevant Opportunity Vs Out of pocket Cost Opportunity cost-amount or subjective value that is forgone in choosing one activity over next best alternative-implicit cost or indirect cost Out of pocket-involve immediate payments to outsiders-direct cost or explicit cost Opportunity cost more relevant than out of pocket cost Sunk Vs Incremental cost Sunk cost-Cost incurred in the past that is not affected by a current decision-irrelevant Incremental cost-change in overall costs that result from particular decisions being made-relevant

RELATIONSHIP BETWEEN PRODUCTION & COST

Production function deals factors of inputs for production

Fixed cost Variable cost

Fixed Cost-cost which remains fixed& do not change with output Variable Cost-vary directly with output Total Cost-sum total of all costs incurred in production Total Cost(TC) =Total Fixed Cost(TFC) + Total Variable Costs(TVC) TC= f(Q)

Output

Shape of total cost curve is exactly same as that of total variable cost same vertical distance always separates two curves Short run total cost curve
250 200 150 100 Cost TFC TVC TC

50
0 0 5 Output

10

SHORT RUN & LONG RUN COSTS

Short run- time period when only one input factor is varied Long run-time period when all inputs can be varied Total Cost, Average Cost & Marginal Cost Total Cost-sum total of explicit + implicit expenditures incurred for producing a given level of output. TC=TFC+TVC

Average Cost- cost per unit of output assuming that production of each unit of output incurs same cost. AC=AFC+AVC OR AC=TC/Q
Marginal Cost-extra cost of producing one additional unit. MC=TC/ Q OR MC= TVC/ Q

Average Fixed Cost(AFC),Average Variable Cost(AVC), Average Total Cost(ATC) & Marginal Cost(MC)
Average Fixed Cost-Fixed cost per unit of output AFC=TFC/Q Average Variable Cost-variable cost per unit of output AVC=TVC/Q TVC=P1V1+P2V2+.+PnVn AVC=(PV)/Q =Px(V/Q) AVC =P/AP where Average Product, AP=Q/V

Average Total Cost-Cost per unit of output ATC=TC/Q =(TVC+TFC)/Q =(TVC/Q)+(TFC/Q) =AVC+AFC Marginal Cost-Additional cost MCn=TCn-TCn-1 MC=d(TC)/dQ MC=d(TFC)/dQ + d(TVC)/dQ MC=d(TVC)/dQ d(TFC)/dQ=0

COST CURVES
AFC-declines continuously with increase in production(Asymptotic curve) AVC-reaches a minimum(MC=AVC) & rises ATC-declines, reaches a minimum(MC=ATC) & then rise MC=first declines, reaches a
minimum(MC=AVC&ATC) & rise

RELATION B/W SHORT RUN COST AND PRODUCTION

AVC=TVC/Q AVC=WL/Q where, W=Wage rate L=Qty of labour Q=Qty produced/Output AVC=W/(Q/L) =W/AP where, AP=Average Product MC=d(TVC)/dQ =d(WL)/dQ =W.dL/dQ =W(L/Q) MC=W/ (Q/L) =W/MP where MP=Marginal Product

Measures responsiveness of TC to a small change in the level of output. Ec= (% Change in TC)/ ( % Change in output) =(TC/TC)/(Q/Q) =(TC/TC)*(Q/Q) =(TC/Q)*(Q/TC) =(TC/Q)/(TC/Q) =MC/AC

Ec =Marginal Cost/Average Cost

A period

of time during which firm can vary all its inputs. Long run cost of production is least possible cost of production of producing any given level of output when all inputs are variable including size of plant No fixed factor of production hence theres no fixed cost Long run production cost curve will start from origin

Q=(L,K) TC=L.PL+K.PK

Returns to scale
Increase in total output as two inputs(K&L) increase Coefficient of output elasticity,

Eq=(% change in Q)/(% change in all inputs)

Increasing returns to scale(Eq>1) Small increase in input results in a larger increase in output

Decreasing returns to scale(Eq<1) Rate of increase of input is faster than rate of increase in output

Constant returns to scale(Eq=1) TC & output move in the same direction & in same proportion

Long run Average Cost(LAC)& Long run Marginal Cost(LMC)

LAC=LTC/Q LMC=(LTC)/(Q) LAC&LMC U shaped curves Point of inflection-increasing returns to scale starts decreasing At point A,LMC-minimum LMC=LAC,LAC is minimum LMC<LAC,LAC curve falls LMC>LAC,LAC curve rise, Area=economies of scale

ECONOMIES OF SCALE
Larger plant will lead to lower per unit cost Beyond some point of success in larger plants indicate higher average cost Law of diminishing returns is not applicable U-shaped long run average cost curve explained in terms of economies & diseconomies of scale economies & diseconomies of scale are concerned with behavior of average cost

ECONOMIES OF SCOPE
When cost advantages are obtained by producing different products(product diversification) within given scale of the plant economies of scale- expansion Economies of scope-diversification

LEARNING CURVE

Describes reduction in cost per unit of output as a firms output increases over a successive period of time,while output per period may remain the same Learning curve relationship between cost output is expressed algebraically as:
(1/x)=K(x^n) where, (1/x)=cost to produce x-th unit K=cost for Kth unit (1st unit) x=no: of product unit n=(log s)/(log 2) s=slope parameter

SUPPLY CHAIN MANAGEMENT

Efforts by a firm to improve efficiencies through each link of a firms supply chain from supplier to customer Goal-to increase profits primarily by reducing costs Deals with both internal & external activities of a firm

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