Supply Managerial Economics Lecturer: Jack Wu

DRAM Industry, 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

Analysis of Short-Run Costs

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

total cost variable cost fixed cost Cost (Thousand $) Production rate (Thousand dozens a week) Short-Run Total Cost

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

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 Short-Run Decisions

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 Short-Run Production produce where marginal cost = price

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

marginal cost average cost marginal revenue = price break-even price Production rate (Thousand dozens a week) Cost/revenue (Cents per dozen) Long-Run Production

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

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) Individual Supply

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 Supply Curve: Two Views

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

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

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 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