Topic 4 - Costs Flashcards
Main Categories of Costs
- Opportunity Costs
- Sunk Costs
- User Cost
Opportunity Cost
Cost of not doing the other best alternative
* Economic Profit = Accounting profit - Opportunity Costs (if not already incurred)
Sunk Cost
Cost which cannot be recovered
- Should no longer affect your decision
User Cost
Cost per user of a durable good, needed to compensate owner during it’s lifetime including opportunity cost
User Cost Formula
User Cost = Capital Cost X (Interest Rate + Depreciation)
* Note: CAPM typically use 8% for the interest rate
* Divide by the number of users for per user cost
Price to Rent Ratio
Ratio of the price of a capital asset to it’s user cost
* ie. Price of capital asset / User cost
Price to Rent Ratio Formula
Price / User cost = 1/(Interest Rate - Depreciation)
* Note: negative sign for depreciation to capture ‘appreciation’
Price to Rent Ratio Rises
- If interest rates fall
- Depreciation increases (Appreciation reduces)
- Expectations impact demand - can be self-fulfilling
Production Costs
- Fixed Costs - Costs the firm is unable to change in the ‘short run’
- Variable Costs - Costs the firm can change in the ‘short run’
- Total Cost - Fixed Cost + Variable Costs
Long Run vs Short Run
- Short Run - Period within which variable costs can be adjusted
-
Long Run - Period within which all costs are variable
- With the exception of sunk costs
Cost of producing one more unit
Marginal Cost
Average Cost
Total Cost / Total Output
Average Fixed Cost
Fixed Cost / Output
Average Variable Cost
Variable Cost / Output
Marginal Cost Formula
Change in Total Cost / Change in Quantity
User Cost Formula - Extra
