SUPPLYMBA NCCU

Managerial Economics

Lecturer: Jack Wu

CASE: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

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

Production Rent Wages Supplies Total0 $2000 $200 $0 $2200

1000 $2000 $529 $100 $26292000 $2000 $836 $200 $30363000 $2000 $1216 $300 $35164000 $2000 $1697 $400 $40975000 $2000 $2293 $500 $47936000 $2000 $3015 $600 $56157000 $2000 $3870 $700 $65708000 $2000 $4862 $800 $76629000 $2000 $5996 $900 $8896

SHORT-RUN WEEKLY EXPENSES

Production FC VC TC MC AFC AVC AC0 $2200 $0 $2200

1000 $2200 $429 $2629 $0.43 $2.2 $0.43 $2.632000 $2200 $836 $3036 $0.41 $1.1 $0.42 $1.523000 $2200 $1316 $3516 $0.48 $0.73 $0.44 $1.174000 $2200 $1897 $4097 $0.58 $0.55 $0.47 $1.025000 $2200 $2593 $4793 $0.7 $0.44 $0.52 $0.966000 $2200 $3415 $5615 $0.82 $0.37 $0.57 $0.947000 $2200 $4370 $6570 $0.95 $0.31 $0.62 $0.948000 $2200 $5462 $7662 $1.09 $0.28 $0.68 $0.969000 $2200 $6696 $8896 $1.23 $0.24 $0.74 $0.99

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

0

2

4

6

8

2 4 6 8

total cost

variable cost

fixed cost

Cost

(Thousa

nd $

)

Production rate (Thousand dozens a week)

SHORT-RUN TOTAL COST

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

0

50

100

150

200

2 4 6 8

Cost

(C

ents

per

doze

n)

Production rate (Thousand dozens a week)

250

300

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

Prodn VC TC TR Profit MC MR0 $0 $2200 $0 -$2,200

1000 $429 $2629 $700 -$1,929 $0.43 $0.72000 $836 $3036 $1400 -$1,636 $0.41 $0.73000 $1316 $3516 $2100 -$1,416 $0.48 $0.74000 $1897 $4097 $2800 -$1,297 $0.58 $0.75000 $2593 $4793 $3500 -$1,293 $0.7 $0.76000 $3415 $5615 $4200 -$1,415 $0.82 $0.77000 $4370 $6570 $4900 -$1,670 $0.95 $0.78000 $5462 $7662 $5600 -$2,062 $1.09 $0.79000 $6696 $8896 $6300 -$2,596 $1.23 $0.7

SHORT-RUN PROFIT, I

0

3.5

4.793

1 5 9

total cost

total revenue

variable cost

loss =$1293

Production rate (Thousand dozens a week)

Cost

/revenue (

Thousa

nd $

)SHORT-RUN PROFIT, II

Two key business decisions:•whether to continue in

operation •scale of operation

SHORT-RUN DECISIONS

70

5

marginal cost

average costaverage variable cost

marginal revenue = price

Production rate (Thousand dozens a week)

Cost

/revenue (

Cents

per

doze

n)

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.

SHORT-RUN INDIVIDUAL SUPPLY: INPUT DEMAND

Change in input price shift in marginal cost change in profit-

maximing production

LONG-RUN DECISIONS

whether to enter/exit price >= average cost

scale of operation where marginal cost = price

LONG-RUN PRODUCTION

FUJITSU

Durham, UK: long-run price < average cost (including cost of refitting)

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

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 supplymay be flat

SELLER SURPLUS

Individual seller surplus = revenue a seller gets from a product - production cost

Market seller surplus = sum of individual seller surpluses

0

43

70

1 5

bc

a

d

marginal cost

marginal revenue= price

individual seller surplus

Production rate (Thousand dozens a week)

Cost

/revenue (

Cents

per

doze

n)

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. 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%?

Item Horizon Price Elasticitydistillate short run 1.57gasoline short run 1.61pork long run 0.23tobacco long run 7housing long run 1.6 - 3.7

PRICE ELASTICITIES

FORECASTING

Forecasting quantity supplied Change in quantity supplied = price elasticity of

supply x change in price