A detailed discussion of the theory and Excel implementation of the calculations, graphs and tables can be found in the following paper and the Excel file.

An Analytical Theory of Major factors in Economics

http://web.unbc.ca/~chenj/papers/AnalyticalTheory.xlsx

Excel implementation of our theory

In our production theory, we aim to obtain results about the relations among fixed costs, variable cost, duration, discount rate and uncertainty from the perspective of return or profit. We will start from some general examples and then go through some more detailed problems.

We will begin by opening an Excel sheet that contains three examples. The first example examines how variable costs change with the level of fixed cost at different levels of uncertainty. From the calculations and the graph, we observe that at low levels of uncertainty, higher fixed cost systems have much lower variable cost. But at high levels of uncertainty, there is little difference of variable cost between high and low fixed cost systems. This explains low fixed cost entities, such as young people, and small organizations are more innovative for they thrive in uncertain environments. For examples, many new IT companies, such as Microsoft, Apple, Netscape, Google are founded by young people. While established authorities mostly reside in large and dominant institutions, new theories were often developed in small institutions by obscure and young figures. Example: Einstein. In ecological systems, small plants flourish in newly or frequently disturbed areas while large trees dominate stable landscapes.

The second example examines the rate of return of systems with different fixed cost with respect to market size or output. From the calculation, low fixed cost systems break even with a smaller output. High fixed cost systems, which have lower variable cost, generate higher rate of return when market size is large. It is easier for small businesses to break even in a niche market. That is why most businesses are of small size. Large businesses, with higher fixed costs, need large revenues to break even. But they often generate high rate of returns in a large market.

The third example illustrates the pattern of increasing return and diminishing marginal profit. These are the most fundamental patterns in businesses. Yet the established theories have hard time to describe them. Yet from our theory, it is very easy.

In the following, we will examine several more detailed examples and discuss their policy implications. Usually, we will apply Solver in Excel to maximize return or profit with respect to major parameters under different conditions.

The first example is from our recent paper, Institutional Structures and Policies in an Environment of Increasingly Scarce and Expensive Resources: A Fixed Cost Perspective. In this paper, we showed that the proper level of fixed cost is determined by the level of resource abundance. When resource is more abundant, we need to invest higher level of fixed cost to achieve high rate of return. When resource is less abundant, invest too much fixed cost will generate lower level of return or even negative rate of return. Calculation and graphs can be found from the Excel sheet. Detailed discussion of the results can be found in the paper.

The second example is from another of our recent paper, A Common Framework for Evolutionary and Institutional Economics. We aim to find the level of fixed cost and duration in an investment at different levels of uncertainty. We will attempt to maximize profit of an investment with respect to fixed cost and duration. Profit is a function of fixed cost, duration of investment and variable cost, which in turn is a function of fixed cost and duration. The results can be found in the Excel sheet. From the Excel sheet, we find that with lower level of uncertainty, the required fixed cost is higher and the duration is longer to achieve highest net present value. However, when uncertainty increases, the high fixed cost, long duration investment usually generate poor outcome with respect to low fixed cost, short duration investment. Detailed discussion of the results can be found in the paper.