Archive for the ‘Cost management’ Category
The economic way of thinking about costs no comments
When economists analyze the firm’s costs, they often present a highly mechanical- some would say unrealistic- view that doesn’t take into account the subjective nature of costs and the uncertainty about the future payoffs of many choices decision makers really face.
It is important to keep in mind that costs are incurred when choices are made.
When business decision makers choose to purchase raw materials, hire new employees, or renew the lease on a plant, they incur costs. All these decisions, like other choices, must be made under conditions of uncertainty. Of course, past experience can help business decision makers anticipate the likely costs of various decisions. But the world is constantly changing; the future may differ substantially from the past.
Opportunity costs are expected costs- they represent the highest valued option that the decision maker expects to give up as the result of a choice. Think for a moment of what the cost curves developed in this series of posts really mean. The firm’s short-run MC curve represents the opportunity cost of expanding output, given the firm’ s current plant size. The firm’s long-run ATC curve represents the opportunity cost per unit of output associated with varying plant sizes and rates of output, given that the alternative plants are still on the drawing board. Opportunity costs look forward, reflecting expectations of what will be forgone as a result of current decisions. At the time decisions must be made, neither the short-run MC nor the long-run ATC can be determined from accounting records, since accounting costs look backward. Accounting figures yield valuable information about historical costs, but, as the following section illustrates, they must be interpreted carefully when they are used to forecast future costs.