FECON 4.2
Terms
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- cost center
- is used when headquarter can measure quantity and quality of output, knows the cost function, and can set the profit maximizing output and rewards, while the cost center has knowledge to choose the optimal input mix to minimize cost subject to an output target, for example : manufacturing units EX: Manager of industry (auto) factory headquarter said you have to produce under a certain amount. Have to figure out how to achieve it (quantity) by doing at the lowest possible cost.
- expense center
- is used when headquarter has difficult to observ eand measure output, while the expense center has knowledge to choose the optimal input mix to minimize cost subject to a fixed level of service satisfaction, EX personnel, accounting and research centers.
- Optimality condition for output constrained cost minimization:
- incremental cost due to the last unit of output through the usage of any input should be the same across all inputs Ex: w-wage rate r-rental cost of capital mpk= marginal product of capital w/mpl= r/mpk further lower the cost 1.planning constraint 2. production stage how to produce EX: planning to go to college
- revenue center
- is used when headquarter has knowledge of demand to set the profit maximizing price for an optimal product input mix (such as advertising and product promotion) to maximize revenue for given price targets and cost budget, for example: retail and wholesale units. -optimality condition for cost constrained revenue mazimization given product price: incremental revenue due to the last dollar spent on each promotion activity should be the same across all promotion activity should the same across all promotion activites. Ex: last dollar spent must be the same as incremental sales revenue. ex buying newspapers
- profit center
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is used when the profit cwenter has the knowledge to choose the optimal input mix and the price or quantity of an optimal product mix to maximize profit, e.g Cadillac division of GM. Profit center consists of revenue cost and expense centers.-Profits maximaization requires marginal revenue equals marginal cost. for the special case of a competitive firm, price is equal to marginal revenue. For firms with market power, price is greater than marginal revenue.
EX: mr=mc ex producing a product if mr>mc produce more if mr
- five sources of market power
- 1essential inputs, economies of scale and scope, product differentiation: quality, warranty, brand name, governement regulation, and entry barrier EX: produce diamond jewlery must have diamonds(debeers monoploy who gets to set their market price. increase output the average profit declines natural monoploy use average cost pricing scope: producing each one together (mc donalds burgers) than producing each one seperate same product but priced differently at each place like kungpao in chinese rest (nice environment?/ served good?) super lotto making it almost impossible to win entry barrier: outside have to pay cost to enter: CPA exam raised from 120 to 150 students