Week 3 — Production and costs

Which of my costs move when I sell one more unit, and how much must I sell to cover the rest?

← Course map

This week you will

  • Sort your company’s costs into fixed and variable, and say which costs are sunk.
  • Compute the two numbers every pricing decision leans on: the contribution-margin ratio and the break-even point.
  • Check whether your company gets cheaper per unit as it grows.

1. Watch

Work through the four concept pages in this order. Each page has a short video at the bottom.

# Concept page Textbook
1 Production and marginal product P&B 5.1, 5.2, 5.4 (words only, no Cobb-Douglas exponents; skip 5.3 and 5.5)
2 Fixed, variable, opportunity and sunk costs P&B 6.1
3 Short-run cost curves and break-even P&B 6.2
4 Long-run costs and economies of scale P&B 6.3 (economies and diseconomies of scale and economies of scope only; skip isocost lines and the cost-minimization math), 6.4 (learning curve); skip 6.5

2. Try

Your numbers come from your company’s 10-K. The Find it in the 10-K guide shows where each one lives.

On each concept page, do the “Try it” box. Then try this company version: airline or bakery?

Once a flight is scheduled, one more passenger costs the airline almost nothing. So an empty seat is worth selling cheap. A bakery pays for every extra loaf in flour and baker time, and past a point each extra baker adds less. Which one does your company look like?

  1. Open your company’s latest 10-K income statement (Item 8). List the cost lines.
  2. Open the cost-structure builder on the cost-concepts page. Press Use my numbers, add each cost line, and mark it Fixed, Variable or Leave out. Write one short reason per line. A streaming service or software firm will show a high CM ratio (one more subscriber costs little; fixed costs carry the risk). A grocer or a restaurant chain will show a much lower one.
  3. Press Save to My Numbers, then Copy classification table and Export PNG. Paste both into your Playbook page.
  4. Write one sentence on scale: did cost per store, per seat-mile or per subscriber fall between the last two years? The two-year sentence tool on the long-run cost page writes it for you.
  5. Write one sentence on sunk costs: which part of your company’s current expansion plan is already spent?

Those steps are Playbook P3.

Class experiment

Anonymous and not graded. The whole class answers one short question; the results appear when it closes.

3. Check yourself

Answer the “Check yourself” questions at the end of each concept page. They are not graded. They tell you if you are ready for the homework.

4. Do in Moodle

  1. Practice Homework U3 — Part A: 8 concept questions; Part B: 6 Excel Lab items with Lab_U3.xlsx (the Neighborhood Bakery).
  2. Playbook Page P3 Cost Structure.
  3. Two peer comments.
This week’s formulas
  • Marginal product: MP of worker n = q(n) − q(n − 1) · diminishing returns begin with the first worker whose MP is smaller than the one before
  • TC = F + VC · AFC = F ÷ q · AVC = VC ÷ q · ATC = TC ÷ q · MC = wage ÷ MP
  • CM ratio = (Revenue − Variable) ÷ Revenue = (p − AVC) ÷ p
  • Break-even revenue = Fixed ÷ CM ratio · break-even quantity = F ÷ (p − AVC)
  • Sunk costs get zero weight in any decision about the future
  • Two-year check: % change in cost per unit = (c₂ − c₁) ÷ c₁, next to the % change in units

Due dates and points are in Moodle.