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

Production 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 FC $2200 $2200 $2200 $2200 $2200 $2200 $2200 $2200 $2200 $2200 VC $0 $429 $836 $1316 $1897 $2593 $3415 $4370 $5462 $6696 TC $2200 $2629 $3036 $3516 $4097 $4793 $5615 $6570 $7662 $8896 MC $0.43 $0.41 $0.48 $0.58 $0.7 $0.82 $0.95 $1.09 $1.23 AFC $2.2 $1.1 $0.73 $0.55 $0.44 $0.37 $0.31 $0.28 $0.24 AVC $0.43 $0.42 $0.44 $0.47 $0.52 $0.57 $0.62 $0.68 $0.74 AC $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

Short-Run Total Cost

Cost (Thousand $) total cost 8 6 4 2 fixed cost 0 2 4 6 8 variable cost

Production rate (Thousand dozens a week)

Short-Run Marginal, Average Variable, and Average Costs

Cost (Cents per dozen)

300 250 200 150 100 50 0 2 4

diminishing marginal product causes marginal and average cost curves to rise
marginal cost average cost average variable cost 6 8

Production rate (Thousand dozens a week)

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 $0.43 $0.41 $0.48 $0.58 $0.7 $0.82 $0.95 $1.09 $1.23 MR $0.7 $0.7 $0.7 $0.7 $0.7 $0.7 $0.7 $0.7 $0.7

Short-Run Profit, II
total cost variable cost total revenue 4.097 2.8
loss = $1297

Cost/revenue (Thousand $)

Production rate (Thousand dozens a week)

Short-Run Decisions Two key business decisions: whether to continue in operation scale of operation

Short-Run Production
Cost/revenue (Cents per dozen)

produce where marginal cost = price

marginal cost

70

average cost average variable cost marginal revenue = price

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.

Long-Run Decisions
 

whether to enter/exit
price >= average cost

scale of operation
where marginal cost = price

Long-Run Production
Cost/revenue (Cents per dozen)
marginal cost

average cost

70
break-even price

marginal revenue = price

3.4 Production rate (Thousand dozens a week)

Fujitsu


Durham, UK: long-run price < average Cost 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, 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

Individual Seller Surplus

Cost/revenue (Cents per dozen) individual seller surplus 70 43 c d b marginal revenue = price marginal cost

a 0 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