Cost Analysis

The first question in everyone’s mind????

 Learning Outcomes

• To understand the various types of cost in a

business process.
• To understand the significance of the cost of
production in managerial decision making.
Role and Relevance of Cost
A Real Life Case
Application of cost optimization
techniques in Industry
 How ICICI Bank leveraged software
robotics to reduce response time to
customers by 60 % and lower cost of
operations
 Robotic Process Automation (RPA) is a technology that
automates routine, standardized and repetitive business
processes performed by the employees by the technology.
 ICICI Bank has become the first bank in the country and
among the few globally to deploy software robotics to
power its internal banking operations.
 The software robots are processing over 10 lakh
transactions daily, bringing in greater operational
efficiency, higher accuracy and a massive reduction in
processing time for customer services and lower average
cost.
 Software robots have reduced the response time to
customers by up to 60 % and increased accuracy to 100%.
 Determinants of cost

 Price of inputs
 Productivity of inputs
 Technology
 Level of output
 Kinds of Cost
 Accounting Cost/ Explicit Cost
 Implicit Cost
 Economic Cost
 Replacement Costs
 Social Costs
 Controllable Costs (fringe benefits to employees, costs of quality
control) and Uncontrollable Costs
 Production Costs and Selling Costs
Short-Run Cost Function

Total Cost = TC = f(Q)

Total Fixed Cost = TFC
Total Variable Cost = TVC
TC = TFC + TVC

.
 Short-Run Cost Function

Average Total Cost = ATC = TC/Q

Average Fixed Cost = AFC = TFC/Q
Average Variable Cost = AVC = TVC/Q
ATC = AFC + AVC
Marginal Cost = TC/Q = TVC/Q

© Oxford University Press,

2016. All rights reserved.
© Oxford University Press, 2016. All rights
reserved.
 Per Unit Cost Curves in Agro
Industries
• Behavior of estimated AVC, ATC and MC per unit for
in-organic fertilizer, agricultural implements, pump
sets, tractors and harvesters.
• Cost curve follow U shape.
• Inorganic fertilizer industry shows a constant rising
cost curve whereas tractor and harvester industry
showed a V-shaped cost curve indicating steep rise
in cost.
Per unit cost curves in Agro
Industries
 Case Study for Homework

Dell PCs and Apple iPhones and iPads sold in the

United States Are Anything but American??
 Long-Run Cost Functions

Long-Run Total Cost = LTC = f(Q)

Long-Run Average Cost = LAC = LTC/Q
Long-Run Marginal Cost = LMC = LTC/Q

© Oxford University Press,

2016. All rights reserved.
 MCQ

1. The costs incurred even when no output is produced are called:

A) fixed costs. B) external costs. C) variable costs. D) marginal costs.

2. It definitely pays a firm to shut down if the price of its product is:
A) below its minimum average variable cost.
B) above its maximum variable cost.
C) above its minimum average variable cost.
D) below its minimum total cost.
3. By producing less, a firm can reduce:

A) its variable costs but not its fixed costs.

B) its fixed costs and its variable costs.
C) its fixed costs but not its variable costs.
D) neither its variable costs nor its fixed costs.

4. If there are external economies, as demand increases:

a. output decreases in the long run.
b. the price falls in the long run.
c. the price rises in the long run.
d. firms exit from the industry in the long run.
5. Implicit costs are:
A) equal to total fixed costs.
B) comprised entirely of variable costs.
C) "payments" for self-employed resources.
D) always greater in the short run than in the long run.
6. When the total product curve is falling, the:
A) marginal product of labor is zero.
B) marginal product of labor is negative.
C) average product of labor is increasing.
D) average product of labor must be negative.
Economies of Scale
 Economies of Scale

The advantages of large scale production that result

in lower unit (average) costs (cost per unit)

AC = TC/Q
 Types of Economies of Scale

Internal Economies
External Economies
 Economies of Scale
Capital Land Labour Output TC AC

Scale A 5 3 4 100

Scale B 10 6 8 300

•Assume each unit of capital = £5, Land = £8 and Labour = £2.

•Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of

production facility
 Types of Internal Economies of Scale

Technical Economies
Commercial Economies
Financial Economies
Managerial Economies
Risk Bearing Economies
Division of Labour Economies
Transportation Economies
 External Economies of Scale

The advantages firms can gain as a result

of the growth of the industry.

Supply of skilled labour

Infrastructure
Training facilities
 Diseconomies of Scale

The disadvantages of large scale production that can

lead to increasing average costs:
Labour Diseconomies
Problems of management
Divorce of ownership and control
Scarcity of resources
 Real Life Example of Economies of
Scale
Narayana Hrudayalaya: The Henry Ford of Heart
Surgery
 Charges Rs. 1 Lakh for open heart surgery compared to hospitals in
US that charges 10 to 50 times .

 Also Economies of Scope as “Dr. Shetty built a 1400 bed cancer

hospital and 300 bed eye hospital, which shared the same
laboratories and blood bank at heart institute”.

 Narayana Hrudayalaya reported 7.7 percent profit after taxes or

slightly above 6.9 % average for US hospitals.
 Economies of Scope

• When the production capacity can be utilized for producing more than
one goods, average costs are less as compared to when they are
produced by different firms separately; e.g. Computers and printers;
heavy vehicles and light vehicles.

3 43
 Minimizing Costs Internationally

• Foreign Sourcing of Inputs

• Immigration of Skilled Labor

• Make in India

© Oxford University Press,

2016. All rights reserved.
A Case Study of Dell
 Apple iPhone

The Components of iPhone are entirely Asian

Screen: Japan

Flash Memory: Korea

Assembled : China

Apple contributed the design and software and integrated the

innovations of the others.
Cost-Volume-Profit Analysis

Total Revenue = TR = (P)(Q)

Total Cost = TC = TFC + (AVC)(Q)
Breakeven Volume TR = TC