PGDM, FORE School of Economics

CASE LETS & COST

ESTIMATION
 COST ESTIMATION
In July 2014, the manager at Rockford Enterprises
decided to estimate the total variable, average
variable, and marginal cost functions for the firm.
The capital stock at Rockford has remained
unchanged since the second quarter of 2012.
The manager collected quarterly observations on
cost and output over this period and the resulting
data were as follows:
COST ESTIMATION
 CONT.
Average variable cost was measured in nominal (i.e., current) dollars, and the cost
data were subject to the effects of inflation.
Over the period for which cost was to be estimated, costs had increased due to the
effects of inflation.
The manager’s analyst decided to eliminate the influence of inflation by deflating
the nominal costs.
Recall that such a deflation involves converting nominal cost into constant-dollar
cost by dividing the nominal cost by an appropriate price index.
The analyst used the implicit price deflator for gross domestic product (GDP)
published in the Survey of Current Business, which can be found at the website for
the Bureau of Economic Analysis (www.bea.gov/scb).
The following values for the price deflator were used to deflate the nominal cost
data:
CONT.
 CONT.
To obtain the average variable cost, measured in constant
(2009) dollars, for the 300 units produced in the second quarter
of 2012, $38.05 is divided by the implicit price deflator 109.16
(divided by 100), which gives $36.26:

$36.26 = $38.05 /109.16 / 100

Note that it is necessary to divide the implicit price deflator by 100

because the price deflators in the Survey of Current Business are
expressed as percentages. Repeating this computation for each of the
average variable cost figures, the manager obtained the following
inflation-adjusted cost data:
CONT.
CONT.
CONT.
NUMERICAL