Final answer:
Broad averaging in cost allocation can lead to undercoating or overcasting of products or services, which affects pricing and profitability. Understanding various cost measures like average total cost helps in making pricing decisions. The long-run average cost curve also illustrates how economies of scale and increased coordination costs impact product costing.
Step-by-step explanation:
When businesses employ broad averaging to allocate costs, they spread the total costs across all products or services equally, rather than on the basis of actual usage or causation. This method can lead to undercoating and overcasting of products or services. Undercoating occurs when the cost allocated to a product is less than the actual cost incurred for that product, potentially causing a business to price its product too low and lose profit. Overcosting happens when the cost allocated is greater than the actual cost, which can lead to overpricing and reduced competitiveness in the market.
Understanding different cost measures, such as average total cost, which is calculated by dividing total cost by the total output at different levels of production, can provide valuable insights for a firm. Average costs typically form a U-shaped curve on a graph. If the average cost of production is lower than the market price for the product, the firm will likely earn profits.
For example, let's consider a scenario with two interpretations of the long-run average cost curve. In one case, a single manufacturing plant might have the same average costs producing 5,000 units as it would producing 20,000 units, indicating economies of scale. However, as a firm grows and possibly adds more plants, coordinating and managing these multiple locations could raise production costs, as suggested by the upward slope of the long-run average cost curve at a certain point.