Agricultural Economics

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AgEc 301 Agricultural Economics I
Slide Set 13 Chapter 8
Learning Curves, Breakeven Analysis
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Learning Curves

• For many processes, average costs decline
  substantially as the total output increases.
• Gains in efficiency are an important part of this
  process.

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Learning Curves

• As you gain experience in any business, you also
  gain knowledge, intuition, and the ability to
  improve methods.
• This should lead to a decline in average costs.

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Learning Curves

• This decline in average costs that comes as a
  result of experience is said to reflect the
  firms Learning Curve.
• The learning curve affects average costs in a way
  similar to any technical advance.

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Learning Curves

• Efficiency gained from experience is reflected in
  a downward shift in the LRAC curve at all levels
  of output.

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Learning Curves

• In order to isolate the effect of learning, it is
  necessary to carefully identify the portion of
  average cost that is changing due to other
  factors.
• Learning curve economies are largest at lower
  levels of output.

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Learning Curves

• Note that only when output scale, technology and
  input prices are held constant can the learning
  curve relation be accurately represented.

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The learning curve reflects the percentage
decline in average costs as total cumulative
output doubles from Qt to 2Qt
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Learning Curve Example

• The learning curve is often characterized as a
  constant percentage decline in average costs as
  cumulative output increases.

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Learning Curve Example

• For example, suppose average costs per unit for a
  new product were 100 in 2001, but fell to 90
  during 2002.
• Assume no change in technology or the general
  price level occurred.

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Learning Curve Example

• Given that output doesnt change (no economies of
  scale occur) the learning rate can be calculated
  as follows

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Learning Curve Example

• So, for the example at hand
• Which 10

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Learning Curve Example

• This rate (10) is defined as the percentage by
  which average cost falls as cumulative output
  doubles.
• Note, cumulative output is output over the life
  of the company.

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Learning Curve Example

• Thus, as cumulative output doubles, in our
  example, average costs are expected to fall by
  10.
• Note, it would take two additional years for
  cumulative output to double again.

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Learning Curve

• One would project that in 2004, other things held
  constant, the average cost per unit will decline
  from 90 to 81 (another 10 decline).

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Strategic Implications of the Learning Curve

• Why is the learning curve phenomenon important?
• Firms that are dominant in a market have the
  opportunity to drive average costs down further
  increasing the dominance of the firm.

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Strategic Implications of the Learning Curve

• Texas Instruments anticipated efficiencies from
  the learning curve to price semiconductors below
  current production costs.
• This allowed them to dramatically increase
  production and they became the dominant industry

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Economies of Scope

• Economies of Scope exist when the cost of joint
  production is less than the cost of producing
  multiple outputs separately.
• A firm will produce products that are
  complimentary in the sense that producing them
  together costs less than producing them
  individually.

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Economies of Scope

• The production of more than one output, or
  offering of more than one service is typical.
• Economies of scope are important because they
  allow firms to exploit skill and experience.

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Economies of Scope

• For example, PepsiCo, Inc. had broadened its
  product line to include Gatorade, Tropicana, and
  many snack foods.
• Moving into juices, sports drinks and snacks
  took advantage of existing distribution and
  advertising networks.

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Cost-Volume-Profit Analysis

• C-V-P analysis is a fancy term for breakeven
  analysis.
• Breakeven analysis is an important analytical
  technique that allows you to examine costs,
  volume and profits over a range of costs and
  volumes.

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Breakeven Analysis

• For simple problems, a graphic method works well
  to illustrate the C-V-P relationships.
• The breakeven point can be depicted graphically
  by plotting total cost and total revenue curves.

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Breakeven Analysis

• Algebraically, we can compute cost, volume,
  profit and breakeven points as follows
• P price per unit sold
• Q quantity produced and sold
• TFC total fixed costs
• AVC average variable costs
• ?c profit contribution

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Breakeven Analysis

• On a per unit basis
• ?c P AVC
• ?c can be applied to cover fixed costs and then
  to provide for profits.

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Breakeven Quantity

• Breakeven quantity (zero profit activity level)
  can be calculated as
• QBE TFC / (P AVC)
• Or
• QBE TFC/ ?c

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Degree of Operating Leverage

• Note that the higher a firms fixed costs, the
  higher the breakeven income.
• The degree of operating leverage is the
  percentage change in profit resulting from a 1
  percent change in units sold.

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Degree of Operating Leverage

• In general the degree of operating leverage can
  be calculated as

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Degree of Operating Leverage

• Which mathematically is

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Degree of Operating Leverage

• In terms of the cost curves, DOL is

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Cost-Volume-Profit Analysis

• While this type of breakeven analysis is useful,
  it also has its limitations.
• Based on constant selling price
• Based on constant average costs
• Based on assumptions made by managers

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Cost-Volume-Profit Analysis

• Note that with spreadsheets, you can always plug
  in a range of prices and costs, and come up with
  a breakeven over a number of contingent values.

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Cost-Volume-Profit Analysis

• More sophisticated software that can perform
  statistical simulations can even give you the
  probability of breaking even given the price and
  cost histories involved.