Managerial Economics & Business Strategy Chapter 5 The Production Process and Costs

Switching to the Long Run Now…K and L are both variable Can plot out optimal choices for K and L Called firm expansion path Best possible input choices when can vary all inputs K C B A L

In SR constrained by capacity… Why?? Can’t change firm size LR can decrease costs to a greater extent because can change all factors of production

Short Run vs. Long Run Short Run assumes FIXED plant size Each plant size has a unique ATC curve associated with it SRATC LRATC combines all the SRATC curves Which points of the SRATC??? Minimum points

Why minimum? LRATC shows the lowest average cost at which a firm can produce any given level of output LRATC is the lower ENVELOPE of the SRATC curves Called envelope curve

Economies of Scale $ LRAC Economies of Scale Diseconomies of Scale Q

Multi-Product Cost Function Most firms do not only produce one good C(Q1, Q2): Cost of jointly producing two outputs. General function form:

Economies of Scope C(Q1, 0) + C(0, Q2) > C(Q1, Q2). Example: When it is cheaper to produce the two outputs jointly instead of separately. Example: It is cheaper for Time-Warner to produce Internet connections and Instant Messaging services jointly than separately. Cheaper to sell fish and chicken in one restaurant rather than have two restaurants specializing in each

Cost Complementarity DMC1(Q1,Q2) /DQ2 < 0. The marginal cost of producing good 1 declines as more of good two is produced: DMC1(Q1,Q2) /DQ2 < 0. Examples: Cow hides and steaks. Doughnut holes and doughnuts

Quadratic Multi-Product Cost Function C(Q1, Q2) = f + aQ1Q2 + (Q1 )2 + (Q2 )2 What are the MC functions? MC1(Q1, Q2) = aQ2 + 2Q1 MC2(Q1, Q2) = aQ1 + 2Q2 Cost complementarity: a < 0 Economies of scope: f > aQ1Q2 C(Q1 ,0) + C(0, Q2 ) = f + (Q1 )2 + f + (Q2)2 f > aQ1Q2: Joint production is cheaper

A Numerical Example: C(Q1, Q2) = 90 - 2Q1Q2 + (Q1 )2 + (Q2 )2 Cost Complementarity? Yes, since a = -2 < 0 MC1(Q1, Q2) = -2Q2 + 2Q1 Economies of Scope? Yes, since 90 > -2Q1Q2

Chapter 5 homework Numbers: 4, 5, 6, 13 and, 17

Managerial Economics & Business Strategy Chapter 6 The Organization of the Firm

Manager’s Role Procure inputs in the least cost manner, like point B. Provide incentives for workers to put forth effort. Failure to accomplish this results in a point like A. Higher costs Achieving points like B managers must Use all inputs efficiently. Get inputs cheap Costs C(Q) A $100 B 80 Q 10

Methods of Procuring Inputs Spot Exchange When the buyer and seller of an input meet, exchange, and then go their separate ways. Contracts A legal document that creates an extended relationship between a buyer and a seller. Vertical Integration When a firm shuns other suppliers and chooses to produce an input internally.