Required:

1. Estimate the relationship between the cumulative average direct labor-hours per unit and
cumulative output (both in logarithms). Verify that the following is the result obtained by Inbee
and Jim:

Regression 1: Ln (Cumulative avg DLH per unit) = a + [b × Ln (Cumulative Output)]

Variable Coefficient Standard Error t-Value

Constant   2.087 0.024 85.44
Independent variable: Ln (Cum Output) –0.208 0.003 –69.046
r = 0.998; Durbin-Watson statistic = 2.66
2

2. Plot the data and regression line for the above estimation. Evaluate the regression using the
criteria of economic plausibility, goodness of fit, and slope of the regression line.
3. Verify that the estimated slope coefficient corresponds to an 86.6% cumulative average-time
learning curve.
4. Based on this new estimation, how will Inbee revise her budget for Hankuk’s variable cost for
the expected output of 650 units in January 2018? How confident is she of this new cost
estimate?

SOLUTION

(30 min.)  Cost estimation, learning curves (continuation of 10-44).

1.  Here is the summary output for the monthly regression of the natural log of Cumulative
Average Direct Labor-Hours per Unit on the natural logarithm of Cumulative Output:

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.9989528
R Square 0.9979068
Adjusted R
Square 0.9976975
Standard Error 0.0074326
Observations 12

ANOVA
Significance
  df SS MS F F
Regression 1 0.263368 0.263368 4767.34 9.89803E-15
Residual 10 0.000552 5.52E-05
Total 11 0.26392      
 Coefficient Standard Upper
  s Error t Stat P-value Lower 95% 95%
Intercept 2.09 0.02 85.44 0.00 2.03 2.14
X Variable 1 -0.21 0.00 -69.05 0.00 -0.21 -0.20

2.  The plot of the data and the regression line estimated above are provided next.

Economic  A negative relationship between cumulative average direct-labor hours per

plausibility unit and cumulative output (in natural logarithms) is economically plausible
and reflects the presence of learning effects. Specifically, as the firm gains
experience via production, it becomes more efficient and is able to use fewer
direct labor hours to make each unit of product.
Goodness of fit r = 99.8%, Adjusted r =  99.8%
2 2

Standard error of regression = 0.007

Unparalleled goodness of fit. Virtually perfect linear fit in logarithms.
Significance of The t-value of -69.05 for the logarithm of cumulative output is significant at
Independent all conventional levels.  The t-value for the intercept (85.44) is highly
Variables significant as well.
3.  The original learning curve specification, y = ax is mathematically identical to the following
b

log-linear specification:
Ln y = Ln a + b × Ln x

The regression equation we have estimated,

Ln (Cumulative avg DLH per unit) = a + (b × Ln (Cumulative Output))

is precisely the above specification, and in particular the slope coefficient directly yields the “b”
from the learning curve equation. We know therefore that for Hankuk electronics, b = -0.208.  As
explained in Exhibit 10-10, this value is related to the learning curve percentage as follows:
 b  =  Ln (learning-curve % in decimal form)/Ln 2, or
-0.208  =  Ln (learning-curve % in decimal form)/0.693, or

Ln (learning-curve % in decimal form)  =  -0.208 × 0.693  =  -0.144.

As the exponent of -0.144 is 0.8659, this implies that Hankuk is experiencing an 86.6%
cumulative average-time learning curve. 

4.  With an additional 650 units in January 2018, Hankuk’s cumulative output will go from 7,527
at the end of December 2016 to 8,177 (7,527 + 650).  As Ln (8,177) = 9.0091, the cumulative
average direct-labor hours in logarithmic terms are given by:

2.0876 – 0.2079 × 9.0091  =  0.2146.

The cumulative direct-labor hours per unit therefore equals Exp (0.2146) = 1.2394. This implies
a total direct labor hours of 1.2394 × 8,177  =  10,134 by the end of January. As Hankuk has
used a total of 9,480 direct labor hours at the end of December 2017, the incremental hours
needed in January therefore are 654 (10,134 – 9,480). At $17.50 per labor hour, this suggest that
Inbee should budget

654 × $17.50  = $11,445

for direct labor costs for January 2018. 

While 9.0091 is outside the range of cumulative output values (measured in logarithms) used to
find the regression equation, unless there has been a structural break in the experience curve
Hankuk is facing, it is highly likely that its January costs will be in the neighborhood of $11,445.
The reason is that the estimated regression line is close to perfect and has a standard error close
to zero. There is virtually no uncertainty around the coefficient estimates.  The slope coefficient,
for example, has a point estimate of -0.2079, and a narrow 95% confidence interval between
-0.2146 and -0.2012.  Using either of those estimates would make barely any difference to the
predicted cost for the month of January 2018