Transcript Of Make Vs Buy Question Video

Now the next problem we have on our list is something called the make versus buy problem. Now what your looking at here is trying to decide, given an output level q0 what is the cheapest way of producing that output… what is the cheapest technology… least expensive… least cost way of doing it. Umm… and for example what you are doing here is simply looking at some volume index that you have… two different technologies, and given some volume index there, which of these two technologies c1 or c2 is the cheapest way of handling it? All there is to it is trying to find the cheap way. Now this could be things like trying to decide whether you should hire a janitor or a janitorial service, whether you should make the lenses that go on the back of the car yourself or should you could have a subcontractor to do it? Its all just the various choice of technologies.

Now the simplest example I have for this one is dealing with Tri-met. Now I take the train, I actually in real life have an annual pass because that’s cheapest for me, but for the most part people don’t have those choices. They usually have only two. Technology number one which is going to be a monthly pass and technology number two is going to be getting the tickets from out of the machine. I’m not exactly sure what the monthly/annual passes costs nowadays, but we’ll do something simple like say… this is say 66 dollars per month and we’ll say that the individual tickets… again I haven’t looked it a while… like a $1.05 per ticket that’s out there. These are very very outdated. I think it’s a lot more expensive than this. Anyway, please note that this monthly cost that we have up here is all fixed costs there’s no variable component… and the tickets right here are all variable costs and there’s no fixed component. So if I ask you what the fixed cost is here you say $60, if I ask you what the average variable cost is you say $0.

On this one, if I ask you what the fixed cost is you say 0$, if I ask you for the average variable cost you say a $1.05… it’s as simple as that. Now what we’re trying to do is choose a technology given that we know what volume we’re going to use. So what I end up doing is saying well look… I probably use the MAX about four times a month, something along those lines. And so what I get to do then is take a look at how these two cost functions are evaluated… at volume of forty in each case. So there’s cost function one, there’s cost function two. Cost function one evaluated at volume of forty is just the 60 dollars. Cost function two evaluated at ah… forty should be… $1.65. What does this go ahead and give you? Ew…. didn’t do the math on it as fast as I thought I did so give me just a sec, I know that you guys have to do this… for me usually… $1.65… 66 bucks. So effectively what you are doing with make versus buy is keeping the cheaper item, and so what you are doing is saying… uhh, this one’s cheaper.

Now most the time we don’t actually use the make versus buy decision like that, uh most the time what we’re trying to do is find out where we start changing what particular technology we’re going to use because we’re afraid we’re near it. Um, this forty is not a whole lot of trips… uh you got to remember that it could be something along the lines of “I know that there’s going to be a lot of events during the month that I will want to come downtown or there’s a lot of time where I come down on the weekend for whatever reason,” we’ll start cracking that up. In real life, I have a significant amount of uncertainty about this particular number that’s sitting around right here.

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