managerial economics lecture four

8/3/2019 Managerial Economics Lecture Four

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Supply

Managerial Economics

Lecturer: Jack Wu



DRAM Industry, 1996-98

Prices falling sharply:

Fujitsu closedD

urham, UK, factorybut continued production at Gresham,

OR

Texas Instruments sold Richardson

TX, Italy, and Singapore plants toMicron

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 ontime horizon which inputs can be adjusted.

Focus on short run, then later consider longrun;

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-R

un 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



Production Rent Wages Supplies Total

0 $2000 $200 $0 $2200

1000 $2000 $529 $100 $2629

2000 $2000 $836

$200 $3

0363000 $2000 $1216 $300 $3516

4000 $2000 $1697 $400 $4097

5000 $2000 $2293 $500 $4793

6000 $2000 $3015 $600 $5615

7000 $2000 $3870 $700 $6570

8000 $2000 $4862 $800 $7662

9000 $2000 $5996 $900 $8896

Short-Run Weekly Expenses



Production FC VC TC MC AFC AVC AC

0 $2200 $0 $2200

1000 $2200 $429 $2629 $0.43 $2.2 $0.43 $2.63

2000 $2200 $836 $3036 $0.41 $1.1 $0.42 $1.52

3000 $2200 $1316 $3516 $0.48 $0.73 $0.44 $1.17

4000 $2200 $1897 $4097 $0.58 $0.55 $0.47 $1.02

5000 $2200 $2593 $4793 $0.7 $0.44 $0.52 $0.96

6000 $2200 $3415 $5615 $0.82 $0.37 $0.57 $0.94

7000 $2200 $4370 $6570 $0.95 $0.31 $0.62 $0.94

8000 $2200 $5462 $7662 $1.09 $0.28 $0.68 $0.96

9000 $2200 $6696 $8896 $1.23 $0.24 $0.74 $0.99

Analysis of Short-

Run Costs



Common Misconception Capital expenditure = fixed cost

Labor = variable cost

Example:

US: workers employed ³at will´.

Western Europe: strong worker protection

laws Japan: guaranteed lifetime employment

Current: temporary workers



0

2

4

6

8

2 4 6 8

total cost

variable cost

fixed cost

C o s t ( T h o u s a

n d

$ )

Production rate (Thousand dozens a week)

Short-R

unT

otal Cost



0

50

100

150

200

2 4 6 8

C

o s t ( C e n t s

p e r d o z

e n )


250

300

marginal cost

average cost average variable cost

Short-Run Marginal, AverageVariable, and Average Costs

diminishing marginal product causes marginal and averagecost curves to rise



Prodn VC TC TR Profit MC MR

0 $0 $2200 $0 -$2,200

1000 $429 $2629 $700 -$1,929 $0.43 $0.7

2000 $836 $3036 $1400 -$1,636 $0.41 $0.7

3000 $1316 $3516 $2100 -$1,416 $0.48 $0.7

4000 $1897 $4097 $2800 -$1,297 $0.58 $0.7

5000 $2593 $4793 $3500 -$1,293 $0.7 $0.7

6000 $3415 $5615 $4200 -$1,415 $0.82 $0.77000 $4370 $6570 $4900 -$1,670 $0.95 $0.7

8000 $5462 $7662 $5600 -$2,062 $1.09 $0.7

9000 $6696 $8896 $6300 -$2,596 $1.23 $0.7

Short-R

un Profit, I



0

2.8

4.097

1 4 9

total cost

total revenue

variable cost

loss =$1297


C o s t / r e v e n u e

( T h o u s a n

d

$ )

Short-R

un Profit, II



Two key business decisions:

whether to continue inoperation scale of operation

Short-R

unD

ecisions



70

5

marginal cost

average cost

average variable cost

marginal revenue = price



( C e n t s

p e r d o z e n )

break-evenprice

Short-R

un Production

produce where marginal

cost = price



ShortR

unB

reakeven I

produce if

total revenue >= variable cost, or

price >= average variable cost



ShortR

unB

reakeven II Sunk cost: cost that has been committed and

cannot be avoided.

sunk costs should be ignored in making acurrent decision

assume, for competitive markets analysis, fixedcost = sunk cost

hence, a business should continue inproduction so long as its revenue coversvariable cost (i.e. shut down if losses aregreater than fixed cost)

or equivalently, so long as price covers

average variable cost.



Short-R

un 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.



Long-Run Decisions

whether to enter/exit price >= average cost

scale of operation where marginal cost = price



0

70

3.4

marginal cost

average cost

marginal revenue= price

break-evenprice


C o

s t / r e v e n u e

( C e n t s

p e r d o z e n )

Long-R

un Production



Fujitsu

Durham, UK: long-run price < average

Cost

Gresham, OR: average variable cost <

short-run price < average cost



Why did Micron buyT

I plants? different views of long-run DRAM price

Micron could achieve greater scaleeconomies

Why didn t Micron buy all of TI s plants?Possible explanation:

Micron Electronics bought TI plants --Singapore, Italy, Richardson TX -- withlower average cost

TI closed plants with higher average cost --Midland TX -- Micron didn t wish to buy



Graph of quantity that seller willsupply at every possible price

follows marginal cost curve

slopes upward -- increasing

marginal cost of production (ordecreasing marginal return to inputs)

Individual Supply



For every possible price, it showsthe production/ delivery rate

For each unit of item, it shows theminimum price that the seller is

willing to accept

Supply Curve: Two Views



Market Supply, I

Graph of quantity that seller willsupply at every possible price

horizont al sum of individual supplycurves



Market Supply, II

lowest cost seller defines startingpoint

gradually, blends in higher-costsellers

slopes upw ard



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 = revenuea seller gets from a product -

production cost Market seller surplus = sum of

individual seller surpluses



0

43

70

1 5

bc

a

d

marginal cost

marginal revenue= price

individual seller surplus



( C

e n t s p e r d o z e n )

d

Individual Seller Surplus



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 goldprice raise profit by 46%?



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



Item Horizon Price Elasticity

distillate short run 1.57

gasoline short run 1.61

pork long run 0.23

tobacco long run 7

housing long run 1.6 - 3.7

Price Elasticities

managerial economics lecture four

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