Transcript Managerial Economics Lecture Four Winter 2015

SUPPLY
Managerial Economics
Lecturer: Jack Wu
DRAM INDUSTRY, 1996-98
Prices falling sharply:
 Fujitsu closed Durham, UK, factory but
continued production at Gresham, OR
 Texas Instruments sold Richardson TX, Italy,
and Singapore plants to Micron
 TI shut Midland, TX plant

QUESTION
Question: explain differences in strategic
decisions:
 why did Fujitsu close Durham?
 why did it continue with Gresham?


Question: Why did Micron buy some TI plants?
BUSINESS RESPONSE TO PRICE CHANGES
If market price falls, should business reduce
production or shut down?
 Correct managerial decision depends on time
horizon – which inputs can be adjusted.

Focus on short run, then later consider long run;
 distinction between short/long run on supply side
similar to that on demand side

ADJUSTMENT TIME
short run: time horizon within which seller
cannot adjust at least one input
 long run: time horizon long enough for seller to
adjust all inputs

SHORT-RUN COST
Analyze total cost into two categories
 fixed cost – do not vary with production scale
 variable cost – does vary
 marginal cost = increase in total cost for
production of additional unit
 average (unit) cost = total cost / production rate
SHORT-RUN WEEKLY EXPENSES
Production
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
Rent Wages
$2000
$200
$2000
$529
$2000
$836
$2000 $1216
$2000 $1697
$2000 $2293
$2000 $3015
$2000 $3870
$2000 $4862
$2000 $5996
Supplies
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
Total
$2200
$2629
$3036
$3516
$4097
$4793
$5615
$6570
$7662
$8896
ANALYSIS OF SHORT-RUN COSTS
P r o d u ctio n
FC
VC
TC
MC
AF C
AV C
AC
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
$2200
$2200
$2200
$2200
$2200
$2200
$2200
$2200
$2200
$2200
$0
$429
$836
$1316
$1897
$2593
$3415
$4370
$5462
$6696
$2200
$2629
$3036
$3516
$4097
$4793
$5615
$6570
$7662
$8896
$0.43
$0.41
$0.48
$0.58
$0.7
$0.82
$0.95
$1.09
$1.23
$2.2
$1.1
$0.73
$0.55
$0.44
$0.37
$0.31
$0.28
$0.24
$0.43
$0.42
$0.44
$0.47
$0.52
$0.57
$0.62
$0.68
$0.74
$2.63
$1.52
$1.17
$1.02
$0.96
$0.94
$0.94
$0.96
$0.99
COMMON MISCONCEPTION
Capital expenditure = fixed cost
 Labor = variable cost
 Example:
 US: workers employed “at will”.
 Western Europe: strong worker protection laws
 Japan: guaranteed lifetime employment
 Current: temporary workers

Cost (Thousand $)
SHORT-RUN TOTAL COST
total cost
8
variable cost
6
4
2
0
fixed cost
2
4
6
8
Production rate (Thousand dozens a week)
DIMINISHING MARGINAL PRODUCT
Marginal product: increase in output from
additional unit of input
 Diminishing marginal product: marginal product
reduces with each additional unit of input

Cost (Cents per dozen)
SHORT-RUN MARGINAL, AVERAGE
VARIABLE, AND AVERAGE COSTS
diminishing marginal product
causes marginal and average
cost curves to rise
300
250
200
marginal cost
150
average cost
100
average variable cost
50
0
2
4
6
8
Production rate (Thousand dozens a week)
MARGINAL REVENUE
Total revenue = price x sales quantity.
 Marginal revenue: change in total revenue from
selling additional unit

May be positive or negative
 If price is fixed, then marginal revenue is equal to
price

SHORT-RUN PROFIT, I
Prodn
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
VC
$0
$429
$836
$1316
$1897
$2593
$3415
$4370
$5462
$6696
TC
$2200
$2629
$3036
$3516
$4097
$4793
$5615
$6570
$7662
$8896
TR
$0
$700
$1400
$2100
$2800
$3500
$4200
$4900
$5600
$6300
Profit
-$2,200
-$1,929
-$1,636
-$1,416
-$1,297
-$1,293
-$1,415
-$1,670
-$2,062
-$2,596
MC
MR
$0.43
$0.41
$0.48
$0.58
$0.7
$0.82
$0.95
$1.09
$1.23
$0.7
$0.7
$0.7
$0.7
$0.7
$0.7
$0.7
$0.7
$0.7
SHORT-RUN PROFIT, II
Cost/revenue (Thousand $)
total cost
variable cost
total revenue
4.097
loss =
$1297
2.8
0
1
4
9
Production rate (Thousand dozens a week)
SHORT-RUN DECISIONS
Two key business decisions:
• whether to continue in
operation
• scale of operation
Cost/revenue (Cents per dozen)
SHORT-RUN PRODUCTION
produce where marginal
cost = price
marginal cost
average cost
average variable cost
marginal revenue = price
70
break-even
price
5
Production rate (Thousand dozens a week)
SHORT RUN BREAKEVEN I
produce if
 total revenue >= variable cost, or
 price >= average variable cost
SHORT RUN BREAKEVEN II





Sunk cost: cost that has been committed and cannot
be avoided.
sunk costs should be ignored in making a current
decision
assume, for competitive markets analysis, fixed cost
= sunk cost
hence, a business should continue in production so
long as its revenue covers variable cost (i.e. shut down
if losses are greater than fixed cost)
or equivalently, so long as price covers average
variable cost.
SHORT-RUN SUPPLY CURVE
individual seller’s supply curve: that part of the
marginal cost curve above minimum average
variable cost;
 minimum average variable cost -- short-run
breakeven level.

SHORT-RUN INDIVIDUAL SUPPLY:
INPUT DEMAND

Change in input price
shift in marginal cost
 change in profitmaximing production

LONG-RUN DECISIONS
whether

price >= average cost
scale

to enter/exit
of operation
where marginal cost = price
LONG-RUN PRODUCTION
FUJITSU
Durham, UK: long-run price < average cost
(including cost of refitting)
 Gresham, OR: average variable cost < short-run
price < average cost

WHY DID MICRON BUY TI PLANTS?
different views of long-run DRAM price
 Micron could achieve greater scale economies

Why didn’t Micron buy all of TI’s plants?
Possible explanation:
 Micron Electronics bought TI plants -- Singapore,
Italy, Richardson TX -- with lower average cost
 TI closed plants with higher average cost -Midland TX -- Micron didn’t wish to buy

INDIVIDUAL SUPPLY
Graph of quantity that seller will
supply at every possible price
• follows marginal cost curve
• slopes upward -- increasing
marginal cost of production (or
decreasing marginal return to inputs)
SUPPLY CURVE: TWO VIEWS
• For every possible price, it shows
the production/ delivery rate
• For each unit of item, it shows the
minimum price that the seller is
willing to accept
MARKET SUPPLY, I
Graph of quantity that seller will
supply at every possible price
 horizontal sum of individual supply
curves
MARKET SUPPLY
MARKET SUPPLY, II
 lowest
cost seller defines starting
point
 gradually, blends in higher-cost
sellers
 slopes upward
LONG-RUN SUPPLY
long run -- freedom of entry and exit
 if a business earns profits

attract new entrants
 increase market supply
 reduce market price


if business making loss, will exit
LONG-RUN SUPPLY CURVE
slope of long-run supply
 gentler than short-run supply
 may be flat
SELLER SURPLUS
 Individual
seller surplus = revenue a
seller gets from a product production cost
 Market seller surplus = sum of
individual seller surpluses
Cost/revenue (Cents per dozen)
INDIVIDUAL SELLER SURPLUS
individual seller surplus
70
43
0
c
marginal cost
b
marginal revenue
= price
d
a
1
5
Production rate (Thousand dozens a week)
BULK ORDER

use bulk order to extract seller surplus
 Sellers
use package deals, two-part tariffs
to extract buyer surplus;
 buyer can apply symmetric concept -- how
to get most out of seller;
 use bulk purchasing to capture all seller
surplus -- Speedy should offer Luna a lump
sum equal to area 0abd plus $1 of seller
surplus to supply a bulk order of 5000
dozen eggs
PROFIT/PRICE VARIATION:
LIHIR GOLD IPO, OCT. 1995

Projected profit in 1999:
$52m if gold price = $400 per ounce
 $76m if gold price = $450 per ounce


Why would a 12.5% increase in gold price raise
profit by 46%?
LABOR SUPPLY
marginal cost of labor -- benefit from alternative
use of time
 with higher wage rate

some people work longer and harder
 however, some might work less

PRICE ELASTICITY OF SUPPLY
percentage by which quantity supplied will change
if the price of the item rises by 1%
 usually, positive number
 supply more elastic with time
PRICE ELASTICITIES
Item
distillate
gasoline
pork
tobacco
housing
Horizon
short run
short run
long run
long run
long run
Price Elasticity
1.57
1.61
0.23
7
1.6 - 3.7
FORECASTING

Forecasting quantity supplied

Change in quantity supplied = price elasticity of
supply x change in price
DISCUSSION QUESTION

Suppose that Jupiter System operates two call
centers, one in the north and another in the
south. The following table reports the total costs
at the two centers for various rates of customer
service.
DISCUSSION QUESTION: CONTINUED
Service rate
Northern
Southern
1000
$5000
$8000
2000
$11000
$16000
3000
$18000
$24000
4000
$26000
$32000
5000
$35000
$40000
DISCUSSION QUESTION : CONTINUED
To serve a total of 5000 calls per day in the
cheapest way, how many calls should the
company serve from the northern center and how
many from the southern center?
 At the service rates that you give for (a), what is
the cost of the last thousand calls from the
northern and the southern centers?
