1. S UPPLY IMBA Managerial Economics Lecturer: Jack Wu

2. DRAM I NDUSTRY, 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

3. Q UESTION 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?

4. B USINESS R ESPONSE TO P RICE C HANGES 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

5. A DJUSTMENT T IME 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

6. S HORT -R UN C OST 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

7. SHORT-RUN WEEKLY EXPENSES

8. ANALYSIS OF SHORT-RUN COSTS

9. C OMMON M ISCONCEPTION 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

10. 0 2 4 6 8 2468 total cost variable cost fixed cost Cost (Thousand $) Production rate (Thousand dozens a week) S HORT -R UN T OTAL C OST

11. 0 50 100 150 200 2468 Cost (Cents per dozen) 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

12. SHORT-RUN PROFIT, I

13. 0 2.8 4.097 149 total cost total revenue variable cost loss = $1297 Production rate (Thousand dozens a week) Cost/revenue (Thousand $) SHORT-RUN PROFIT, II

14. Two key business decisions: whether to continue in operation scale of operation S HORT -R UN D ECISIONS

15. 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 S HORT -R UN P RODUCTION produce where marginal cost = price

16. S HORT R UN B REAKEVEN I produce if total revenue >= variable cost, or price >= average variable cost

17. S HORT R UN B REAKEVEN 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.

18. S HORT -R UN 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.

19. L ONG -R UN D ECISIONS whether to enter/exit  price >= average cost scale of operation  where marginal cost = price

20. 0 70 3.4 marginal cost average cost marginal revenue = price break-even price Production rate (Thousand dozens a week) Cost/revenue (Cents per dozen) L ONG -R UN P RODUCTION

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

22. W HY DID M ICRON 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

23. 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) I NDIVIDUAL S UPPLY

24. 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 S UPPLY C URVE : T WO V IEWS

25. M ARKET S UPPLY, I Graph of quantity that seller will supply at every possible price horizontal sum of individual supply curves

26. M ARKET S UPPLY, II lowest cost seller defines starting point gradually, blends in higher-cost sellers slopes upward

27. L ONG -R UN S UPPLY 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

28. L ONG -R UN S UPPLY C URVE slope of long-run supply gentler than short-run supply may be flat

29. S ELLER S URPLUS Individual seller surplus = revenue a seller gets from a product - production cost Market seller surplus = sum of individual seller surpluses

30. 0 43 70 15 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

31. B ULK O RDER 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

32. P ROFIT /P RICE V ARIATION : L IHIR G OLD IPO, O CT. 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%?

33. L ABOR S UPPLY 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

34. P RICE E LASTICITY OF S UPPLY percentage by which quantity supplied will change if the price of the item rises by 1% usually, positive number supply more elastic with time

35. P RICE E LASTICITIES

36. DISCUSSION QUESTION 1 Until 1998, there were two major American manufacturers of DRAMs – Texas Instruments (TI) and Micron Technology. Then, TI sold its factories in Avezzano (Italy), Richardson (Texas), and Singapore, and interests in two Asian joint ventures to Micron Technology. TI shut the remainder of its DRAM production facilities including one in Midland, Texas.

37. DISCUSSION QUESTION 1: CONTINUED Which probably had the higher average cost – the Richardson or Midland plant? Compare the effects on the world wide long-run DRAM supply of TI’s sale of the Richardson plant with its closure of the Midland factory. Explain Micron’s decision to buy TI’s plants in terms of differences between the two companies in their expectations of long-run DRAM prices.

38. DISCUSSION QUESTION 2 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.

39. DISCUSSION QUESTION 2: CONTINUED Service rateNorthernSouthern 1000$5000$8000 2000$11000$16000 3000$18000$24000 4000$26000$32000 5000$35000$40000

40. 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?