2014 Managerial Economics Stefan Markowski Managerial Economics Stefan Markowski How? When? What? The economics of competitive advantage Why? Where? Who? Production processes and production technologies

Detailed course schedule Day no TopicTextbook ch. 1 (24 Nov; 3 hrs) 1. Introduction. Decision making process and its elements. The scope of economic decision making. Application of marginal analysis Chs (25 Nov; 3 hrs) 2. Demand analysis and demand elasticitiesCh. 3 3 (26 Nov; 3 hrs) 3. Buyer product valuation and choices. Consumer surplus. Buyer pricing decisions Ch. 4 4 (27 Nov; 2 hrs) 4. Production/transformation process. Production technologies and input-output structure Ch. 5 5 (28 Nov; 2 hrs) 5. Cost structure and cost drivers of producer pricing strategies. Production scale and scope. Chs. 5 and 7 6 (1 Dec; 3 hrs) 6. Structure-conduct-performance. Market structures: competition and contestability. Pricing strategies of buyers and sellers Ch. 8 7 (2 Dec; 3 hrs) 7. Market structures: monopoly/monopsony. monopolistic competition and oligopoly. Pricing strategies and strategic behaviour Chs (3 Dec; 3 hrs) 8. Input sourcing and investment. Pricing and market powerChs. 6 and 11 9 (4 Dec; 2 hrs) 9. Decision making under conditions of uncertainty. Informational asymmetries and risk management Ch (5 Dec; 2 hrs) 10. Market research and market analysis. Auction and rings. Strategic behaviour Ch (8 Dec; 2 hrs ) 11. Public sector perspectiveCh (9 Dec; 2 hrs) 12. Revision 13. Examination 13 (11 Dec; 2 hrs) Examination

Topic 4: Production process, production technologies and input-output structure Topic Contents 4.1Managerial perspective 4.2 Production decision 4.3 Production process 4.4 Short and long runs 4.5 Production decision in the short run 4.6 Production decision in the long run 4.7 Scale and scope 4.8Linking prices to production 4.9 Short run costs 4.10 Long run costs 4.11 Returns to scale and scope 4.12 Further reading

4.1 Managerial Perspective: Definitions We now turn to suppliers and how the supply side of market exchange is determined. The supplier must determine: –output specificationscope scale –output specification, including product range (scope) and volume (scale) size –types and volumes of inputs to be used (e.g., size of facility) technologies –production technologies scheduling –production scheduling –distribution chain –distribution chain and logistic support Suppliers firmsSuppliers are defined as organisations that combine inputs such as labour, knowledge, land, materials, and equipment for the purpose of producing outputs. These supplying organisations are called firms maximise profitsWe assume that firms are motivated by the desire to maximise profits, i.e., they maximise the difference between revenue and cost

4.2 Production Decision basic production decisionThe basic production decision: –what to produce –how much to produce –when to produce –how much input to use to produce output at least cost The supplier must consider the profit formula at the margin Incremental (Marginal) Profit = Additional (Marginal) Revenue - Additional (Marginal) Cost

4.2 Production Decision Business Rule Consider the level of output when MR = MC If also Average Revenue > or = Average Cost this is the optimal output level to produce Marginal Profit = MR - MC Maximum Profit if Marginal Profit = 0 hence MR = MC

4.3 Production Process process of productionThe process of production is normally described as a transformation of inputs into outputs production functionA production function is a table, graph or mathematical formula showing the maximum output that can be produced from a given level of inputs input-outputA simple input-output relationship of one output and two inputs (capital-machines and labour-operatives) is considered first (re: next two slides) technique of productionEvery combination of inputs is called a technique of production technology of productionAll the techniques there are comprise the technology of production production capacityThe supplier’s production capacity is determined by the maximum output that could be produced using different techniques, given the production technology

4.3 Production Process Input-Output Relationship (one output, two inputs) Machines (Capital) Output (X) _________________________________________ Operatives (Labour)

4.3 Production Process Figure Input-Output Relationship Output (one output, two inputs) Total Product Marginal Product Operatives (Variable)/ Machines (Fixed)

4.3 Production Process production function Generalise this into a two-input-one-output production function: Q = f (L,K), where K - capital L - labour Q = f (kL,kK) = k n f(L,K) k - constant (scale factor) degree of homogeneity, n - degree of homogeneity, i.e., change in output Q in response to a k per cent change in both inputs n = 0 homogenous of degree 0 (if all inputs change by k, there is no change in output) constant returns to scale n = 1 constant returns to scale increasing returns to scale n > 1 increasing returns to scale (scale economies) decreasing returns to scale n < 1 decreasing returns to scale (scale diseconomies)

4.4 Short and Long Runs Long runLong run - the period of time in which all and any inputs can be varied (e.g., when a new firm is planned) Short runShort run - the period of time in which only some inputs can be varied (variable inputs) and at least one input is fixed (fixed input) Short and long runs are about degrees of freedom in making decisions about inputs. Not to be confused with the time passing

4.5 Production Decision in the Short Run Total productTotal product shows how levels of output depend on the level of a variable input, all other inputs being fixed or held constant Average productAverage product is the amount of output per unit of variable input Marginal productMarginal product is the extra output produced when one more unit of variable input is employed

4.5 Production Decision in the Short Run law of diminishing marginal returnsThe law of diminishing marginal returns states that if increasing amounts of variable input (say, labour) are applied to a constant level of a fixed input (say, capital), eventually output will only increase by a diminishing amount In the short run, the challenge is to make the best use of the variable input by maximising its productivity given the fixed amount of the other input That means producing in the range where the Marginal Product of the variable input declines but remains positive (above the horizontal axis)

4.5 Production Decision in the Short Run Total, Average and Marginal Products in the Short Run Output/Product efficient production Total Product Average Product Marginal Product Labour (variable) Capital (fixed)

4.6 Production Decision in the Long Run Long Run Input-Output Relationship Isoquants Machines (Capital) Machines (Capital) Output (X) _________________________________________ Operatives (Labour)

4.6 Production Decision in the Long Run In the long run all inputs are free to vary Q = Q(K,L) Substitutecomplementary inputsSubstitute and complementary inputs KK K/L Q Q L L

4.7 Scale and Scope Most production processes produce many outputs using many inputs (Q a, Q b, Q c ) = (K, L, T) where Q a, Q b, Q c are different product lines Size Size - measured with reference to an input at full capacity Scale Scale - measured with reference to an output at full capacity Scope Scope - measured with reference to a range of products that could be produced

4.8 Linking Prices to Production Combine input prices and quantities to produce costs K P k + L P L = Cost of Q Short runlong run costsShort run and long run costs Explicitimplicit costsExplicit and implicit costs Opportunity costOpportunity cost Sunk costSunk cost

4.9 Short Run Costs Short-run Costs Costs($)Total Cost Marginal Cost Marginal Revenue = AR Average Total Cost (SRAC) Q*Quantity

4.10 Long Run Costs Long-run Costs Costs ($) SAC 1 SAC 3 LRAC SAC 2 LRAC MR=AR Q* Q Output

4.11 Returns to Scale and Scope Returns to Scale Average Cost ($) minimum efficient scale Quantity EconomiesConstant ReturnsDiseconomies

4.11 Returns to Scale and Scope Returns to Scope (Decreasing) Total Cost ($) Product A Product B

4.12Further reading Baye (2010): ch. 5