1. Managerial Economics & Business Strategy
Chapter 5
The Production Process and Costs

2. Switching to the Long Run
Now…K and L are both variable
Can plot out optimal choices for K and L
Called firm expansion path
Best possible input choices when can vary all inputs K C B A L

3. In SR constrained by capacity…
Why??
Can’t change firm size
LR can decrease costs to a greater extent because can change all factors of production

4. Short Run vs. Long Run Short Run assumes FIXED plant size
Each plant size has a unique ATC curve associated with it
SRATC
LRATC combines all the SRATC curves
Which points of the SRATC???
Minimum points

5. Why minimum?
LRATC shows the lowest average cost at which a firm can produce any given level of output
LRATC is the lower ENVELOPE of the SRATC curves
Called envelope curve

6. Economies of Scale $
LRAC
Economies
of Scale
Diseconomies
of Scale Q

7. Multi-Product Cost Function
Most firms do not only produce one good
C(Q1, Q2): Cost of jointly producing two outputs.
General function form:

8. Economies of Scope C(Q1, 0) + C(0, Q2) > C(Q1, Q2). Example:
When it is cheaper to produce the two outputs jointly instead of separately.
Example:
It is cheaper for Time-Warner to produce Internet connections and Instant Messaging services jointly than separately.
Cheaper to sell fish and chicken in one restaurant rather than have two restaurants specializing in each

9. Cost Complementarity DMC1(Q1,Q2) /DQ2 < 0.
The marginal cost of producing good 1 declines as more of good two is produced:
DMC1(Q1,Q2) /DQ2 < 0.
Examples:
Cow hides and steaks.
Doughnut holes and doughnuts

10. Quadratic Multi-Product Cost Function
C(Q1, Q2) = f + aQ1Q2 + (Q1 )2 + (Q2 )2
What are the MC functions?
MC1(Q1, Q2) = aQ2 + 2Q1
MC2(Q1, Q2) = aQ1 + 2Q2
Cost complementarity: a < 0
Economies of scope: f > aQ1Q2
C(Q1 ,0) + C(0, Q2 ) = f + (Q1 )2 + f + (Q2)2
f > aQ1Q2: Joint production is cheaper

11. A Numerical Example: C(Q1, Q2) = 90 - 2Q1Q2 + (Q1 )2 + (Q2 )2
Cost Complementarity?
Yes, since a = -2 < 0
MC1(Q1, Q2) = -2Q2 + 2Q1
Economies of Scope?
Yes, since 90 > -2Q1Q2

12. Chapter 5 homework
Numbers: 4, 5, 6, 13 and, 17

13. Managerial Economics & Business Strategy
Chapter 6
The Organization of the Firm

14. Manager’s Role Procure inputs in the least cost manner, like point B.
Provide incentives for workers to put forth effort.
Failure to accomplish this results in a point like A.
Higher costs
Achieving points like B managers must
Use all inputs efficiently.
Get inputs cheap
Costs
C(Q) A
$100 B 80 Q 10

15. Methods of Procuring Inputs
Spot Exchange
When the buyer and seller of an input meet, exchange, and then go their separate ways.
Contracts
A legal document that creates an extended relationship between a buyer and a seller.
Vertical Integration
When a firm shuns other suppliers and chooses to produce an input internally.