University of Moratuwa

MBA in Management of Technology

Department of Management of Technology

Cover Sheet for Assignment

Name with Initials: M.A.T.P.D. Jayawardena, C.L. Kumbalatara,I.W.

Liayanage,
K.W.A.R.I. Ranasinghe ,R.N. Sanjeewani

Student Registration No: 119012U, 119016K, 119020R, 119032F, 119036V

Title of Assignment: CASE STUDY NO 02 RAIL ROAD CASE

Assignment No:……02…………. Group Individual

Subject Code: MN 5205

Subject: ECONOMICS FOR BUSINESS

Lecturer: Prof. Sarath WSB Dasanayaka

Student’s Statement:
We certify that We have not plagiarized the work of others or participated in
unauthorized collusion when preparing this assignment.

Signature:………………….. Date:…………………….

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Deadline Met Extension Given Late Submission

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Question 01. Do managers often find it difficult to minimize the costs? If so why?
 Yes. Minimizing the costs is one of the extremely tough task faced by the managers. The
major reason is that there is always a relationship between cost and all sort of activity within an
organization. In this case study, minimizing cost has become extremely difficult due to large
number of freight yards and fairly complex distribution of them over long distances. There are
lot of concealed heterogeneity making it difficult for the managers to calculate the exact cost.

A cost function may be either linear or nonlinear. In this case study , the general formula
for a non linear relationship is Ci = 4,914+ 0.42Si+2.44 Di where Ci is the estimated value of a
cost item for any specified value of S(Switches) and D(deliveries) (activity).

The constant 4,914, the intercept, is the fixed cost element; 0.42 and 2.44 the slopes, are
the variable rate per unit of S and Ds . The possible measures of activities S and D include so
many functions within the organization. In this Railroad case study, the production is actually
measured in the no of Switches or cars and Deliveries. So such units of Switches and Deliveries
produced may depend on following factors;

a. The technology available

b. Labour
c. Ancillary services included such as car maintenance, repairs, storage etc
d. Types of freight (coal, livestock, perishable, automobiles etc..)
e. No of engine hours
f. Maintenance cost
g. Distance hauled

Question 2; Can control charts of the sort described in this case help managers to minimize the
costs? If so how?
In everyday life we are faced with large number figures such as prices in stores, taxes, children’s
ratings at school, sport results. The same is true at work. There we face figures such as orders,
production costs, yields, defect rates, salaries, etc.
Variations of numbers are a constant issue. If we are reasoning just by intuition, we tend either to
overestimate them or to neglect them, according to our previous knowledge or experiences. On
the other hand, control charts can give us a better vision of many problems and decisions we
can make using them are more effective.

Control charts help managers in eliminating waste by allowing to evaluate the stability of a
particular process, determine the mean and the variability within the process, and monitor the
effects to improve the process. Controlling costs has an immediate short run positive impact on
financial performance. Lower costs mean higher profits. Investing in quality management
initiatives, such as employee training and acquisition of high quality equipment, often requires
costs now that provide benefits later. Incurring costs now has a short run negative impact on
financial performance.
The drawing of control charts and making some calculations in order to know if a process is
stable, leads managers to consider good news, bad news, data, ratings, etc. If it is done regularly,
the exercise changes the relative importance that people attach to events, therefore it changes the
organization of their memory. It also removes from people’s minds a lot of preconceived ideas.

Question 3 : Is equation 1 a short run or long run cost function? Why?

The equation given in the case study, Ci = 4,914+ 0.42Si+2.44 Di, is a short run cost
function. To understand the reason for our claim, it is necessary to identify the difference
between Long run and short run cost functions.

The short run cost function for a particular manufacturing or service organization is the
relationship between cost and output. That is the cost incurred in producing various levels of
output. Different organizations will have different short run cost functions. The short run is a
period of time in which the quantity of at least one input is fixed and the quantities of the other
inputs can be varied.
The long run is a period of time in which the quantities of all inputs can be varied. In the
long run, firms change production levels in response to (expected) economic profits or losses,
and the land , labour, capital cost and entrepreneurship vary to reach associated long-run
average cost. In the simplified case of plant capacity as the only fixed factor, a generic firm can
make these changes in the long run:

• enter an industry in response to (expected) profits

• leave an industry in response to losses
• increase its plant in response to profits
• decrease its plant in response to losses.

Since the situation in this case meet the requirement of short run case and does not meet any
properties of long run cost functions, we can conclude that this a short run cost function.

Question 4. What is the marginal cost of switching a cut?

The marginal cost of an additional unit of output is the cost of the additional inputs needed to
produce that output. In other words, we can explain it as the derivative of total production costs
with respect to the level of output.
Ci == 4914 + 0.42Si + 2.44Di ------------------- Equation 1
Ci- Expected cost in yard operation in ‘i’th day
Si- Nunber of Cuts switched on in ‘i’th day
Di- Nunber of Cars Delivered on in ‘i’th day
In this case the Switching cuts cost is 0.42 US$, which is the marginal cost of Switching a cut.

Question 5. What is the marginal cost of delivering a car? US$ 2.44

The total cost in yard operation per a selected day results the relationship of;
Ci == 4914 + 0.42Si + 2.44Di ------------------- Equation 1
Ci- Expected cost in yard operation in ‘i’th day
Si- Nunber of Cuts switched on in ‘i’th day
Di- Nunber of Cars Delivered on in ‘i’th day
Marginal cost of delivering a car is a change in the total cost by change in one unit of switching a
Delivery of a car
Expected cost in yard when increase of one unit of delivered car;
Ci* = 4914 + 0.42Si + 2.44( Di + 1) ------------------- Equation 2
ΔCi = Ci* - Ci
 From Equation 2 and 1
ΔCi= 2.44
Marginal cost if delivering a car is 2.44 $.

Question 6. Does the average cost per cut switched exceed the marginal cost of switching a
cut?
Average cost or unit cost is equal to total cost divided by the number of goods produced
(the output quantity, Q). It is also equal to the sum of average variable costs (total variable
cost(VC) divided by Q) plus average fixed costs (FC)(total fixed cost divided by Q).

Total cost is variable cost and fixed cost combined.

TC=VC+FC

Now divide total cost by quantity of output to get average total cost. ATC=TC/Q
Marginal cost function is a derivative of the cost function. To get the cost function, we
need to do the opposite, that is, integrate. MC= D(TC)/D(Q)
The marginal cost is factored into the average total cost at every unit. Because of fixed
cost, marginal cost almost always begins below average total cost. As quantity increases, ATC
will decrease and MC will increase. Eventually they intersect, then MC continues to increase and
pulls ATC up after it.
Therefore, until the break even point reached, the average cost is higher than the marginal
cost. After reaching the break even point, the average cost is reducing and it is less than marginal
cost.

Question 7. In what ways can these estimates of marginal and average cost be useful to railroad
managers .
Average total cost can be very handy for firms to compare efficiency at different output
or when adjusting different factors of production. A firm's marginal cost curve also acts as its
supply curve. By calculating the and plotting these curves, managers can calculate the breakeven
points and also use the predictions to calculate following which will be extremely useful in long-
term sustainability of the business.
a. Minimum qty to be produced to break even.
b. The expected average income
c. Marketing decisions to improve the business
d. Analyzing of fixed costs
e. Controlling of variable costs
f. Labour decisions
g. Roper analyzing of total business process