1. Costs and production

2. Detailed course schedule
Day no
Topic
Textbook 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. 1-2
2 (25 Nov; 3 hrs)
2. Demand analysis and demand elasticities
Ch. 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. 9-10
8 (3 Dec; 3 hrs)
8. Input sourcing and investment. Pricing and market power
Chs. 6 and 11
9 (4 Dec; 2 hrs)
9. Decision making under conditions of uncertainty. Informational asymmetries and risk management
Ch. 12
10 (5 Dec; 2 hrs)
10. Market research and market analysis. Auction and rings. Strategic behaviour
Ch. 13
11 (8 Dec; 2 hrs )
11. Public sector perspective
Ch. 14
12 (9 Dec; 2 hrs)
12. Revision
13. Examination
13 (11 Dec; 2 hrs)
Examination

3. Topic 5: Cost structure and cost drivers of producer pricing strategies Production scale and scope Topic Contents
5.1 Managerial perspective 5.2 Profit maximisation rule 5.3 Economic and accounting costs and profits 5.4 The supply schedule for a price taker 5.5 Price maker’s supply decision 5.6 Supply elasticity
5.7 Multi-plant supplier
5.8 Producer surplus
5.9 Multi-product pricing
5.10 Pricing in practice
5.11 Questions for self- assessment and review
5.12 Further reading

4. 5.1 Managerial perspective
Supply decision - here we focus on price and quantity
Market power
price takers
price makers (extreme case - monopoly)
Multi-plant suppliers
Multi-product suppliers

5. 5.2 Profit maximisation rule
Chose the level of output such that marginal revenue equals marginal cost, providing that the total revenue (or average revenue) is greater than the total cost (or the average cost) at that output level
MR = MC
subject to TR > TC
or AR > AC

6. 5.2 Profit maximisation rule
Revenues
Costs
Total Costs
Total Revenue
Loss Breakeven Profit Breakeven Output

7. 5.2 Profit maximisation rule
Optimal Input Combination
Capital
Isocost line 6
Expansion path
Q2 Isoquant Q1
Labour

8. 5.3 Economic and accounting costs and profits
Accountants focus on historical records of explicit costs
Economists consider explicit and implicit (opportunity) costs, especially the marginal cost (sunk costs are irrelevant as bygones are bygones)
Zero or normal profit is the minimum/necessary rate of return needed by a competitive supplier to stay in a particular business in the long run
It is an ambiguous concept as “zero” means zero above normal profit
Note that profit is a residual difference between the revenue and cost at the end of the accounting period so maximising it beforehand is also ambiguous

9. 5.4 The supply schedule for a price taker
Costs and Prices
Marginal Cost
P b Average Total Cost
P1 a Average Variable Cost
Quantity

10. 5.4 The supply schedule for a price taker
Suppliers maximise profits where
MR = MC s.t. AR > AC
For a price taker MR = AR = Price
Supply curve is therefore the locus of points where MC = P
which is the segment of the MC curve above the Average Variable Cost Curve
Short-run Supply Curve - is shown as the segment of the MC curve above the Average Variable Cost (above point a in the figure above)
Long-run Supply Curve - is shown as the segment of the MC curve above the Average Total Cost (above point b in the figure)

11. 5.4 The supply schedule for a price taker
Shut-down decision
if prices drop below P1 in the short-run
if prices drop below P2 in the long-run
Entry Decision - if prices are expected to be no less than P2 in the long run (above normal profits)

12. 5.4 The supply schedule for a price taker
Movement Along and Shifts of the Supply Curve
Price
Supply C Supply A Supply B P0
Decrease in Increase in
supply supply
Quantity

13. 5.4 The supply schedule for a price taker
Market Supply
Price
Supplier A Supplier B Market Supply
P0 horizontal addition
Qa Qb SQa+Qb Quantity

14. 5.5 Price maker’s supply decision
Market power to influence price
Business Decision Rule
MR = MC s.t. AR > AC
But MR = AR = Price
Price maker has no supply curve He/she sets a particular price-quantity combination for each market demand schedule

15. 5.5 Price maker’s supply decision
Costs and Prices
Marginal Cost
P* Average Total Cost
Demand = Average
Revenue
Q* Marginal Revenue Quantity
Economics for Managers

16. 5.6 Supply elasticity Price Elasticity of Supply
% Change in Quantity Supplied
PES =
% Change in the Product Price
PES may be sensitive to changes in the supply lead time
supply less elastic in short-run
supply more elastic in long-run

17. 5.6 Supply elasticity Price Perfectly Inelastic Inelastic Elastic
Quantity

18. Multi-plant, horizontally-integrated firm (single product)
5.7 Multi-plant supplier
Multi-plant, horizontally-integrated firm (single product)
Costs/Revenue
MCa MCb MCfirm = MCa+MCb P*
Demand
Qa* Qb* Q* MR Quantity
Economics for Managers

19. 5.7 Multi-plant supplier
Add (horizontally) all plant marginal cost curves (e.g., MCa and MCb) to obtain
MCfirm = MCa+MCb
Set MR = MCfirm to determine Q* and P*
Set MCa = MCb = P* to determine Qa* and Qb*

20. 5.8 Producer surplus
Producer surplus is the difference between the revenue obtained by the supplier and its full cost of production. It is a measure of the profitability of supply
The supply curve shows the seller’s willingness to sell different product quantities at various prices

21. 5.8 Producer surplus
Price Supply
Producer Surplus
Quantity

22. 5.9 Multi-product pricing
Suppliers should consider economies of scope and advantages of tied sales
Tied sales - selling goods together rather than separately, especially complements
Bundling - selling a package of own products with those of other firms (eg, an own boat and another firm’s boat trailer)

23. 5.10 Pricing in Practice
Mark-up pricing - adding a percentage to the cost
Price lining - targeting a price or price band to reduce the cost of marketing and product tailoring to buyers
Skimming - introducing a new product at an initially high price to gradually reduce it over time (eg, CD market)
Prestige pricing - targeting those who judge quality by price

24. 5.11 Questions for self-assessment and review
Basic concepts and applications
(1) Define the following
(a) Production function
(b) Marginal product of an input/factor of production
(c) Returns to scale
(d) Economies of scale
(e) Returns to scope
(f) Diseconomies of scope
(2) What is the difference between economic and business profits?
(3) What is the difference between the 'short run' and the 'long run' in economics?

25. 5.11 Questions for self-assessment and review
(4) Why does the 'conventional' supply curve slope upward?
(5) Can you give an example of a flat (horizontal) supply curve? Why is it flat?
(6) How is the supply schedule related to the supply curve?
(7) What factors determine the quantity of a good that a seller is willing to supply?
(8) Define (own) price elasticity of supply
(9) Why is the price elasticity of supply likely to be lower in the short run than in the long run?
(10) What does producer/seller surplus measure?
(11) Draw an illustrative supply curve for:
(a) price taker
(b) price maker

26. 5.11 Questions for self-assessment and review
(12) What does mark-up pricing involve?
(13) Consider the following production function and fill in the values for marginal product of labour:
Output
Number of operatives
Marginal product … … … … … … … of labour
With which operative does diminishing marginal product set in?

27. 5.11 Questions for self-assessment and review
(14) Sketch a figure that represents each of the following situations:
(a) the production function exhibits increasing returns to scale and diminishing marginal product for both of its two inputs
(b) the production function exhibits constant returns to scale and constant marginal products for both inputs
Although you do not need to draw the figures to scale, be sure to label your axes and indicate why your figure illustrates the situation
(15) Does a change in the technology of making computer keyboards lead to a movement along or a shift in the supply of PCs?
(16) What is the price elasticity of supply of 'land' in central business districts (CBDs) of European capital cities?

28. 5.12 Further reading
Baye (2010): chs. 5 and 7