Page 143 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes 3. Output (units) 2,000 4,000 5,000
Cost per unit 100 £100 £80
Explain which type of cost the above figures represent.
4. A liberal arts college created a new business school. The overhead items – library, registrar,
classrooms and offices – were already in place or substantially so. No additional central
administration personnel had to be added at first, only faculty and staff for the new school.
The cost of these positions, plus the modest marketing budget, were more than offset by
the new b-school's tuition income in the second year of operation. There was every
indication that enrollment, and tuition, would grow.
Shortly after the school's creation, the college's provost decided it would be a good idea
to embark on a cost-allocation exercise. Provost and CFO decided on a "fair" formula
that allocated central administration overhead according to each school's use of office,
classroom, and laboratory square footage. Suddenly, the business school, still ramping
up its enrollment, didn't look so good. It more than covered its incremental cost, but
barely paid back its allocated cost in the current year. Its newly hired dean had been
promised the full attention of the college's fundraising office. After all, the b-school's
revenue was "free" in terms of incremental cost, and who wouldn't want more of that?
After the cost-allocation project, however, the college's president decided one of its older,
better-established schools deserved a higher fundraising priority.
What do you think was the problem with the college? How can it be rectified?
5. Raman has a widget producer with one widget producing machine that costed him 1000
last year. He wants to see if he should buy an appliance that paints the widgets yellow,
fetching 100 more per widget. But he has no idea if this is a good investment. In your
evaluation of the investment, do you include the cost of the widget machine? Why/why
not?
6. Why do increasing opportunity costs exist? Illustrate with examples.
7. Why are variable costs more relevant than fixed costs in short-term decision-making?

8. With the increase in output of the firms, their average total cost and average variable cost
curves come closer and closer to each other but never meet. Why?
9. Show the circumstances where the marginal cost is constant throughout but the average
cost is falling.

10. Can the short run average total cost ever be less than the long run average total cost?
11. The output and total cost data for a firm are given below. Work out the following costs:
TFC, TVC, AFC, AVC, ATC and MC at various levels of output.
Units of output 0 1 2 3 4 5 6
Total Cost ( ) 120 180 200 210 225 260 330
12. Suppose that the short run costs for a paintbrush manufacturer are given by the expression:
TC = 100+2Q+0.01 Q 2
(a) What are the fixed costs of this manufacturer?

(b) What are the total costs, average cost, average variable cost and marginal cost at 50
and 100 units of output?
(c) At what output is average cost the minimum?

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