Cost Concepts
Cost Concepts for Managerial Decision Making
Prepared for instructional use in
Economics For Managers
ECG 507
College of Management
North Carolina State Universiy
© Stephen E. Margolis 2000
Soon we will be using the concepts of cost that are presented in Landsburg’s chapters five and six to analyze market behavior of firms. With a bit of interpretation, however, these concepts have immediate application to ordinary decisions that firms make on a daily basis. The first three sections of this essay should help to establish the connections between the economics textbook treatment of cost and these decision problems. The final section presents some examples of decision problems that exercise these cost concepts
I. Foundations: Three Normative Principles
There are three simple but general normative principles that underpin rational or profit maximizing choice. They are: Opportunity cost, comparison of costs and benefits, and incrementalism.
A. Evaluate opportunity costs.
Opportunity cost is the concept of cost in economics. The cost of any action is the value of what is forgone as a result of the action. If an activity does not displace something else, then we could say that it has no cost. Of course, it seems a bit odd to suggest that an action does not have some cost. That is because almost any activity will displace something.
In some instances, opportunity cost is manifest as ordinary or explicit cost. It is "out of pocket expenditure" or more simply, "expenditure." So, for example, a project might require that we hire five people for one day each, at a cost of $200.00 per person per day. The expenditure is an opportunity cost: We must forgo something worth $1000 in order to undertake the project.
Sometimes opportunity costs can be more remote. Imagine that a firm owns a factory and is considering using a portion of the factory for assembling laptop
Prepared for instructional use in
Economics For Managers
ECG 507
College of Management
North Carolina State Universiy
© Stephen E. Margolis 2000
Soon we will be using the concepts of cost that are presented in Landsburg’s chapters five and six to analyze market behavior of firms. With a bit of interpretation, however, these concepts have immediate application to ordinary decisions that firms make on a daily basis. The first three sections of this essay should help to establish the connections between the economics textbook treatment of cost and these decision problems. The final section presents some examples of decision problems that exercise these cost concepts
I. Foundations: Three Normative Principles
There are three simple but general normative principles that underpin rational or profit maximizing choice. They are: Opportunity cost, comparison of costs and benefits, and incrementalism.
A. Evaluate opportunity costs.
Opportunity cost is the concept of cost in economics. The cost of any action is the value of what is forgone as a result of the action. If an activity does not displace something else, then we could say that it has no cost. Of course, it seems a bit odd to suggest that an action does not have some cost. That is because almost any activity will displace something.
In some instances, opportunity cost is manifest as ordinary or explicit cost. It is "out of pocket expenditure" or more simply, "expenditure." So, for example, a project might require that we hire five people for one day each, at a cost of $200.00 per person per day. The expenditure is an opportunity cost: We must forgo something worth $1000 in order to undertake the project.
Sometimes opportunity costs can be more remote. Imagine that a firm owns a factory and is considering using a portion of the factory for assembling laptop