7/28/2019 Engineering 110 Spring 2013 Week 1
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Engineering110Week1handout TA:RaviRamakrishnan
04/05/2013ProductionandCostStructure:Agoalofbusinessesistomaximizeprofit.Todothis
theyneedtofigureouthowtostructurethemselvesanddeterminetheoptimallevel
ofproduction.Inordertodothistheymustdefinetheirinputsandthevariouscosts
associatedwiththem.SunkCostsArecoststhatareincurredbeforewemakedecisionsaboutour
business.Sincetheyoccurredinthepasttheydonotaffectdecisionswemakeinthe
present.Forexampleifwespentabilliondollarsonaprojectourdecisionto
continuetheprojectonlydependsontherevenuesandcostswewillincurnotthe
priorinvestment(sunkcosts).
OpportunityCostsAnyresourcesweuseonaprojectwillbedivertedfromanother
project.Theprofitlostfromnotpursuingthealternativeprojectisopportunitycost.
ThatisifIgotocollegeIcannotsimultaneouslyworkafulltimejob.Thelostwages
frommydecisionareanopportunitycost.ShortRunvs.LongRun
theshortrunisdefinedbythefactthatsomefactorsof
productioncannotbeincreasedordecreased.Thatisheavyequipment,factories,
etc,taketimetobecomeoperational.Thistimeintervalistheshortrun.Thelong
runisdefinedbytheabilitytochangeallfactorsofproduction.
FixedCostsAnycostthatdoesnotdependonproductionlevel.Ittypicallydoesnot
existinthelongrun.ForexampleifIleasefactoryspacemyleasepaymentsbecomeafixedcostuntilthetermofleaseends.
VariableCostsAnycostthatdependsonproduction.IfIwanttoproducemoreshirtsIwouldneedtopurchasemorefabric.Thusfabriccostisvariable.
TotalCost-isthesumofvariableandfixedcosts.Rememberthatopportunitycosts
areimbeddedintotalcost.
LawofDiminishingReturnsInitiallyadditionalresourceswillbringmoreandmore
benefitafteracertainpointtheybringlessbenefitperunitofresource.Forexample
ifIbuyfriesforluncheachfrywillbringmehappinessafterawhilethoughthetaste
(benefit)perfrybeginstodiminish.
EconomiesofScaleAsweincreasethescaleofproduction(i.e.increasefactorysize)theminimumaveragetotalcost(totalcost/quantity)decreases.
MarginalCostAdditionalcostthatisincurredbyproducingonemoreunitofgood.
