SUPPLY
May 27, 2015
SUPPLY
DRAM INDUSTRY, 1996-98Prices 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
QUESTIONQuestion: 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 TIMEshort 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 COSTAnalyze total cost into two categoriesfixed cost – do not vary with production scale variable cost – does varymarginal 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
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 REVENUETotal revenue = price x sales quantity.
Marginal revenue: change in total revenue from selling additional unitMay 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
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 BREAKEVEN Iproduce 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/exitprice >= average cost
scale of operation where marginal cost = price
LONG-RUN PRODUCTION
FUJITSUDurham, 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 priceMicron 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, IGraph of quantity that seller will supply at every possible price horizontal sum of individual supply curves
MARKET SUPPLY
MARKET SUPPLY, IIlowest cost seller defines starting pointgradually, blends in higher-cost sellersslopes upward
LONG-RUN SUPPLYlong run -- freedom of entry and exit
if a business earns profitsattract 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 supply
may be flat
SELLER SURPLUSIndividual seller surplus = revenue a seller gets from a product - production costMarket 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)
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%?
LABOR SUPPLYmarginal cost of labor -- benefit from alternative use of time
with higher wage ratesome people work longer and harder
however, some might work less
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
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
FORECASTINGForecasting quantity suppliedChange in quantity supplied = price elasticity of supply x change in price
DISCUSSION QUESTIONSuppose 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.
DISCUSSION QUESTION: CONTINUED
Service rate Northern Southern
1000 $5000 $8000
2000 $11000 $16000
3000 $18000 $24000
4000 $26000 $32000
5000 $35000 $40000
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?