MIND MAP

Cost-Benefit Analysis
1. Goal
- Recognize the mistakes; and
- Identify profitable decisions
2. Variable, Fixed, and Total Cost
- There are two components of Total Cost: Variable Cost and Fixed Cost
- Variable Cost: This is the cost that varies or changes as the level of the output changes.
- Fixed Cost: Unlike Variable, it does not change or vary even if the there are changes in quantity
of the goods and services in the business.
* irrelevant in extent decision
3. Accounting profit does not necessarily correspond with economic profit
- Accounting profit: recognize explicit Costs only.
- Economic profit: recognize both explicit and implicit costs.
- The difference between these two kinds of profits has a significant effect in making a decision
whether to buy or sell an asset.
- Accounting cost example:
* Cost of Sales
* Operating expenses: Selling, General and, Administrative expense and Depreciation
and Amortization expense
* Other expenses
- Economist: interested in all relevant cost which includes implicit costs – additional costs that do
not appear on the financial statements.
- a business may show an accounting profit but also at the same is experiencing an economic loss.
- A manager must consider all the benefits and costs of a decision.
4. Opportunity Cost
- by definition: the cost of the loss from the other alternatives that were not chosen.
- rule: always choose the alternative that has the highest benefit from all the alternatives.
* to do this: compute the marginal customer acquisition cost for both alternatives and then shift
spending toward the cheaper one.
5. two mistakes:
A. Sunk-Cost Fallacy:
- Consider the irrelevant costs. These are the costs that have been incurred by the business and
cannot be recovered.
 - common cause:
* overhead cost
* depreciation
B. Hidden-Cost Fallacy
- occurs when relevant costs are ignored
6. Struggling with the decisions
- remember 2 things
i. recognize the relevant benefit and cost decisions.
- when deciding always remember cost are defined by the decisions you are trying to
make.
- if you begin by looking at the costs, you will always get confused; if you begin with the
decisions you are considering, you will never get confused.
ii. consider the consequences of your decision from the point of view of the organization.
7. Marginal Analysis
A. Marginal Cost
- Additional cost incurred by producing or selling one more unit
B. Marginal Revenue
- Additional revenue gained by selling one more unit
- Remember: do more if Marginal Revenue is greater than the Marginal Cost, do less if otherwise.
- It brings you to the right path of making decisions bur it does not tell you how far to go.
- Can use to design Incentives for sales and employees
* Sales: Induced higher effort