Supply

1
Supply

• MBA NCCU
• Managerial Economics
• Lecturer Jack Wu

2
CaseDRAM 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

3
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?

4
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

5
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

6
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

7
SHORT-RUN WEEKLY EXPENSES
8
ANALYSIS OF SHORT-RUN COSTS
9
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

10
Short-Run Total Cost
total cost
8
variable cost
6
Cost (Thousand )
4
2
fixed cost
0
2
4
6
8
Production rate (Thousand dozens a week)
11
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

12
SHORT-RUN MARGINAL, AVERAGE VARIABLE,
AND AVERAGE COSTS
diminishing marginal product causes marginal and
average cost curves to rise
300
Cost (Cents per dozen)
250
200
marginal cost
150
average cost
100
average variable cost
50
0
2
4
6
8
Production rate (Thousand dozens a week)
13
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

14
SHORT-RUN PROFIT, I
15
SHORT-RUN PROFIT, II
total cost
variable cost
total revenue
4.793
loss 1293
3.5
Cost/revenue (Thousand )
0
1
5
9
Production rate (Thousand dozens a week)
16
Short-Run Decisions

• Two key business decisions
• whether to continue in operation
• scale of operation

17
Short-Run Production
produce where marginal cost price
Cost/revenue (Cents per dozen)
marginal cost
average cost
average variable cost
70
marginal revenue price
5
break-even price
Production rate (Thousand dozens a week)
18
Short Run Breakeven I

• produce if
• total revenue gt variable cost, or
• price gt average variable cost

19
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.

20
Short-Run supply curve

• individual sellers supply curve that part of
  the marginal cost curve above minimum average
  variable cost
• minimum average variable cost -- short-run
  breakeven level.

21
Short-run individual supply Input demand

• Change in input price
• shift in marginal cost
• change in profit-maximing production

22
Long-Run Decisions

• whether to enter/exit
• price gt average cost
• scale of operation
• where marginal cost price

23
Long-run production
24
Fujitsu

• Durham, UK long-run price lt average cost
  (including cost of refitting)
• Gresham, OR average variable cost lt short-run
  price lt average cost

25
Why did Micron buy TI plants?

• different views of long-run DRAM price
• Micron could achieve greater scale economies
• Why didnt Micron buy all of TIs 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 didnt wish to buy

26
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)

27
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

28
Market Supply, I

• Graph of quantity that seller will supply at
  every possible price
• horizontal sum of individual supply curves

29
Market supply
30
Market Supply, II

• lowest cost seller defines starting point
• gradually, blends in higher-cost sellers
• slopes upward

31
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

32
Long-Run Supply Curve

• slope of long-run supply
• gentler than short-run supply
• may be flat

33
Seller Surplus

• Individual seller surplus revenue a seller gets
  from a product - production cost
• Market seller surplus sum of individual seller
  surpluses

34
INDIVIDUAL SELLER SURPLUS
marginal cost
individual seller surplus
b
c
70
marginal revenue price
d
d
Cost/revenue (Cents per dozen)
43
a
0
1
5
Production rate (Thousand dozens a week)
35
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

36
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?

37
Price Elasticities
38
FORECASTING

• Forecasting quantity supplied
• Change in quantity supplied price elasticity of
  supply x change in price