1. IMBA Managerial Economics Lecturer: Jack Wu
Supply
IMBA Managerial Economics
Lecturer: Jack Wu

2. Supply Two fundamental building blocks of managerial economics: demand
costs-- we discuss from two perspectives
as building block for model of competitive markets -- current chapter;
as basis for strategic business decisions -- Chapter 7

3. Bestar, Canadian furniture manufacturer
2003
2004
2005
Revenue (C$ ‘000)
44,300
43,700
38,700
Restructuring costs (C$ ‘000)
n.a.
1,400
Net earnings (C$ ‘000)
254
-442
174

4. Bestar How do changes in wood prices affect furniture industry?
How do Asian manufacturers affect supply of furniture in North America?
Should Bestar shut down?

5. DRAM Industry, 1996-98 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

6. 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?

7. 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

8. 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

9. 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

10. Short-Run Weekly Expenses

11. Analysis of Short-Run Costs

12. 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

13. Short-Run Total Cost total cost 8 variable cost Cost (Thousand $) 6 42
fixed cost 2 4 6 8
Production rate (Thousand dozens a week)

14. 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

15. Short-Run Marginal, Average Variable, and Average Costs
diminishing marginal product causes marginal and average cost curves to rise
300
Cost (Cents per dozen)
250
200
marginal cost
150
average cost
100
average variable cost 50 2 4 6 8
Production rate (Thousand dozens a week)

16. 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

17. Short-Run Profit, I

18. Short-Run Profit, II total cost variable cost total revenue 4.097 2.8
loss =
$1297
2.8
Cost/revenue (Thousand $) 1 4 9
Production rate (Thousand dozens a week)

19. Two key business decisions: whether to continue in operation
Short-Run Decisions
Two key business decisions:
whether to continue in operation
scale of operation

20. Short-Run Production produce where marginal cost = price
Cost/revenue (Cents per dozen)
marginal cost
average cost 70
average variable cost
marginal revenue = price
break-even
price 5
Production rate (Thousand dozens a week)

21. Short Run Breakeven I produce if total revenue >= variable cost, or
price >= average variable cost

22. 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.

23. 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.

24. Short-run individual supply: Input demand
Change in input price
shift in marginal cost
change in profit-maximing production

25. whether to enter/exit scale of operation Long-Run Decisions
price >= average cost
scale of operation
where marginal cost = price

26. Long-run production Profit-maximizing rule:
produce where price equals marginal cost
same in the long run as for the short run -- but use long-run price and long-run marginal cost
Same analysis for manufacturing and services
manufacturing -- production rate, eg, for auto producer, no. of automobiles per year
service -- operating rate, eg, for telecoms carriers, no. of minutes per month

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

28. Bestar Why didn’t Bestar shut down?
Short-run price  average variable cost
How could Bestar procure new financing?
Long-run price  average cost

29. 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

30. Graph of quantity that seller will supply at every possible price
Individual Supply
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)

31. Supply Curve: Two Views
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

32. Graph of quantity that seller will supply at every possible price
Market Supply, I
Graph of quantity that seller will supply at every possible price
horizontal sum of individual supply curves

33. Market supply

34. lowest cost seller defines starting point
Market Supply, II
lowest cost seller defines starting point
gradually, blends in higher-cost sellers
slopes upward
market supply begins with lowest-cost seller;
each new seller comes into market supply according to
for short run: its minimum average variable cost
for long run: its minimum average cost

35. 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

36. slope of long-run supply gentler than short-run supply may be flat
Long-Run Supply Curve
slope of long-run supply
gentler than short-run supply
may be flat

37. Market seller surplus = sum of individual seller surpluses
Individual seller surplus = revenue a seller gets from a product - production cost
Market seller surplus = sum of individual seller surpluses

38. Individual Seller Surplus
marginal cost c b 70
marginal revenue
= price
Cost/revenue (Cents per dozen) d d 43 a 1 5
Production rate (Thousand dozens a week)

39. 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 dozen eggs

40. Profit/Price Variation: Lihir Gold IPO, Oct. 1995
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%?

41. 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

42. 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

43. Price Elasticities

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

45. 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.

46. Discussion Question: continued
Service rate
Northern
Southern
1000
$5000
$8000
2000
$11000
$16000
3000
$18000
$24000
4000
$26000
$32000
5000
$35000
$40000

47. Discussion Question 2: 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?