S UPPLY Managerial Economics Lecturer: Jack Wu

DRAM I NDUSTRY, 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

Q UESTION 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?

B USINESS R ESPONSE TO P RICE C HANGES 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

A DJUSTMENT T IME 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

S HORT -R UN C OST 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

ANALYSIS OF SHORT-RUN COSTS

C OMMON M ISCONCEPTION 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

total cost variable cost fixed cost Cost (Thousand $) Production rate (Thousand dozens a week) S HORT -R UN T OTAL C OST

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

Cost (Cents per dozen) Production rate (Thousand dozens a week) marginal cost average cost average variable cost SHORT-RUN MARGINAL, AVERAGE VARIABLE, AND AVERAGE COSTS diminishing marginal product causes marginal and average cost curves to rise

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

SHORT-RUN PROFIT, I

total cost total revenue variable cost loss = $1297 Production rate (Thousand dozens a week) Cost/revenue (Thousand $) SHORT-RUN PROFIT, II

Two key business decisions: whether to continue in operation scale of operation S HORT -R UN D ECISIONS

70 5 marginal cost average cost average variable cost marginal revenue = price Production rate (Thousand dozens a week) Cost/revenue (Cents per dozen) break-even price S HORT -R UN P RODUCTION produce where marginal cost = price

S HORT R UN B REAKEVEN I produce if total revenue >= variable cost, or price >= average variable cost

S HORT R UN B REAKEVEN 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.

S HORT -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.

S HORT - RUN INDIVIDUAL SUPPLY : I NPUT DEMAND Change in input price shift in marginal cost change in profit- maximing production

L ONG -R UN D ECISIONS whether to enter/exit  price >= average cost scale of operation  where marginal cost = price

L ONG - RUN PRODUCTION

F UJITSU Durham, UK: long-run price < average cost (including cost of refitting) Gresham, OR: average variable cost < short-run price < average cost

W HY DID M ICRON 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

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) I NDIVIDUAL S UPPLY

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 S UPPLY C URVE : T WO V IEWS

M ARKET S UPPLY, I Graph of quantity that seller will supply at every possible price horizontal sum of individual supply curves

M ARKET SUPPLY

M ARKET S UPPLY, II lowest cost seller defines starting point gradually, blends in higher-cost sellers slopes upward

L ONG -R UN S UPPLY 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

L ONG -R UN S UPPLY C URVE slope of long-run supply gentler than short-run supply may be flat

S ELLER S URPLUS Individual seller surplus = revenue a seller gets from a product - production cost Market seller surplus = sum of individual seller surpluses

bc a d marginal cost marginal revenue = price individual seller surplus Production rate (Thousand dozens a week) Cost/revenue (Cents per dozen) d INDIVIDUAL SELLER SURPLUS

B ULK O RDER 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

P ROFIT /P RICE V ARIATION : L IHIR G OLD IPO, O CT 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%?

L ABOR S UPPLY 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

P RICE E LASTICITY OF S UPPLY percentage by which quantity supplied will change if the price of the item rises by 1% usually, positive number supply more elastic with time

P RICE E LASTICITIES

FORECASTING Forecasting quantity supplied Change in quantity supplied = price elasticity of supply x change in price

DISCUSSION QUESTION Suppose that Jupiter System operates two call centers, one in the north and another in the south. The following table reports the total costs at the two centers for various rates of customer service.

DISCUSSION QUESTION: CONTINUED Service rateNorthernSouthern 1000$5000$ $11000$ $18000$ $26000$ $35000$40000

DISCUSSION QUESTION : CONTINUED To serve a total of 5000 calls per day in the cheapest way, how many calls should the company serve from the northern center and how many from the southern center? At the service rates that you give for (a), what is the cost of the last thousand calls from the northern and the southern centers?