1. COST FUNCTIONS and related concept

2. Cost Function in the short run C = C(Q) C = rK + wL F : Fixed Cost wL(Q) variable costs C Q Q* F Average Cost: AC = C/Q Q Q* AC Marginal Cost : Cm = dC/dQ Cm Qi Ci ACi = Ci/Qi CM = Cm

3. About flexibility… Q* CM Price Margin Critical output Some issues: To which extent has the choice of more capital intensive technologies influenced the degree of flexibility? Why is a broader client base likely to partly solve the flexibility constraint ? With reference to flexibility, analyse the strategic advantage provided by capacity subcontracting Higher flexibility (green curve), the probability of an output lower than the critical level is reduced

4. A close look at the steel industry….. Cost per ton tons Market price efficient output Price effect volume effect margin loss years Higher cost due to lower quantities Lower price due to competition pressure Price and unit cost Recommended reading: The economist June 30, 2001- Steel, a tricky business, p 57

5. The steel industry Capital intensive activity …and high price volatility 9495969798 ROCE* : 4,4% 7,2% 0,5% 3,6% 9,1% * Return On Capital Employed (before tax), USINOR Group

6. Cost Function in the long run Determination K L Q1Q1 C1C1 Q C Q1Q1 C1C1 Q2Q2 C2C2 Q2Q2 C2C2 Q 3 C 3 Q3Q3 C3C3 QC(Q) = minimum cost for an output Q

7. Cost Function: long run Average Cost and Economies of Scale Q AC Optimal size (efficient scale) Economies of scale Origin ? Organisation of labour Access to capital intensive most efficient technologies

8. Cost Function: long run Average Cost and Economies of Scale Paris- WinnyIsland, daily air link Alternative technological choices

9. Cost Function: long run Economies of scale differ from: Economies of scope Synergies Gains from expérience

10. Economies of scale Issues to discuss What changes can you predict in the industry following a significant increase of the efficient scale ? To which extent can we consider economies of scale create entry barriers ? What is the influence of economies of scale on the structure and organisation of industrial groups ? Do you think economies of scale are important in the insurance industry ?