100
80
Where?
How? When?
What?
Why?
2015
60
East
West
North
40
20
0
1st Qtr
2nd Qtr 3rd Qtr 4th Qtr
Who?
Managerial Economics
Stefan Markowski
Costs and production
The economics of competitive advantage
Detailed course schedule
Day no
Topic
Textbook ch.
1 (24 Nov;
3 hrs)
1. Introduction. Decision making process and its elements. The scope of
economic decision making. Application of marginal analysis
Chs. 1-2
2
3
3
3
2. Demand analysis and demand elasticities
Ch. 3
3. Buyer product valuation and choices. Consumer surplus. Buyer pricing
decisions
Ch. 4
4 (27 Nov;
2 hrs)
4. Production/transformation process. Production technologies and input-output
structure
Ch. 5
5 (28 Nov;
2 hrs)
5. Cost structure and cost drivers of producer pricing strategies. Production
scale and scope.
Chs. 5 and 7
6 (1 Dec; 3
hrs)
6. Structure-conduct-performance. Market structures: competition and
contestability. Pricing strategies of buyers and sellers
Ch. 8
7 (2 Dec; 3
hrs)
7. Market structures: monopoly/monopsony, monopolistic competition and
oligopoly. Pricing strategies and strategic behaviour
Chs. 9-10
8 (3 Dec; 3
hrs)
8. Input sourcing and investment. Pricing and market power
Chs. 6 and 11
9 (4 Dec; 2
hrs)
9. Decision making under conditions of uncertainty. Informational asymmetries
and risk management
Ch. 12
10 (5 Dec;
2 hrs)
10. Market research and market analysis. Auction and rings. Strategic
behaviour
Ch. 13
11 (8 Dec;
2 hrs )
12 (9 Dec;
2 hrs)
11. Public sector perspective
Ch. 14
13 (11
Dec; 2 hrs)
Examination
(25 Nov;
hrs)
(26 Nov;
hrs)
12. Revision
13. Examination
Topic 5: Cost structure and cost drivers
of producer pricing strategies
Production scale and scope
Topic Contents
5.1
Managerial
perspective
5.7
Multi-plant
supplier
5.2
Profit maximisation
rule
5.8
Producer surplus
5.9
Multi-product
pricing
5.10
Pricing in practice
5.11
Questions for selfassessment and
review
5.12
Further reading
5.3
Economic and
accounting costs and
profits
5.4
The supply schedule
for a price taker
5.5
Price maker’s
supply decision
5.6
Supply elasticity
5.1 Managerial perspective
• Supply decision - here we focus on price and quantity
• Market power
– price takers
– price makers (extreme case - monopoly)
• Multi-plant suppliers
• Multi-product suppliers
5.2 Profit maximisation rule
Chose the level of output such that marginal
revenue equals marginal cost, providing that the
total revenue (or average revenue) is greater
than the total cost (or the average cost) at that
output level
MR = MC
subject to TR > TC
or AR > AC
5.2 Profit maximisation rule
Profit Maximisation
Revenues
Costs
Total Costs
Total Revenue
Loss
Breakeven
Profit
Breakeven
Output
5.2 Profit maximisation rule
Optimal Input Combination
Capital
Isocost line
6
4
Expansion path
2
Q2 Isoquant
Q1
3
6
9
12
15
Labour
5.3 Economic and accounting
costs and profits
• Accountants focus on historical records of explicit costs
• Economists consider explicit and implicit (opportunity)
costs, especially the marginal cost (sunk costs are
irrelevant as bygones are bygones)
• Zero or normal profit is the minimum/necessary rate of
return needed by a competitive supplier to stay in a
particular business in the long run
• It is an ambiguous concept as “zero” means zero above
normal profit
• Note that profit is a residual difference between the
revenue and cost at the end of the accounting period so
maximising it beforehand is also ambiguous
5.4 The supply schedule
for a price taker
Costs and Prices
Marginal Cost
P2
P1
b
a
Average Total Cost
Average Variable Cost
Quantity
5.4 The supply schedule
for a price taker
• Suppliers maximise profits where
MR = MC s.t. AR > AC
• For a price taker
MR = AR = Price
• Supply curve is therefore the locus of points where
MC = P
which is the segment of the MC curve above the Average
Variable Cost Curve
• Short-run Supply Curve - is shown as the segment of the
MC curve above the Average Variable Cost (above point a
in the figure above)
• Long-run Supply Curve - is shown as the segment of the
MC curve above the Average Total Cost (above point b in
the figure)
5.4 The supply schedule
for a price taker
• Shut-down decision
– if prices drop below P1 in the short-run
– if prices drop below P2 in the long-run
• Entry Decision - if prices are expected to be no
less than P2 in the long run (above normal
profits)
5.4 The supply schedule
for a price taker
Movement Along and Shifts of the Supply Curve
Price
Supply C
Supply A
Supply B
P0
Decrease in
Increase in
supply
supply
Quantity
5.4 The supply schedule
for a price taker
Market Supply
Price
Supplier A
P0
Supplier B
Market Supply
horizontal
addition
Qa
Qb
SQa+Qb
Quantity
5.5 Price maker’s supply decision
• Market power to influence price
• Business Decision Rule
MR = MC s.t. AR > AC
But MR = AR = Price
Price maker has no supply curve He/she sets a particular
price-quantity combination for each market demand
schedule
5.5 Price maker’s supply decision
Costs and Prices
Marginal Cost
P*
Average Total Cost
Demand = Average
Revenue
Q*
Marginal
Revenue
Economics
for Managers
Quantity
5.6 Supply elasticity
• Price Elasticity of Supply
% Change in Quantity Supplied
PES =
% Change in the Product Price
• PES may be sensitive to changes in the supply lead time
– supply less elastic in short-run
– supply more elastic in long-run
5.6 Supply elasticity
Price
Perfectly Inelastic
Inelastic
Elastic
Perfectly
Elastic
Quantity
5.7 Multi-plant supplier
Multi-plant, horizontally-integrated firm
(single product)
Costs/Revenue
MCa
MCb
MCfirm = SMCa+MCb
P*
Demand
Qa *
Qb* Q*
MR
Economics
for ManagersQuantity
5.7 Multi-plant supplier
• Add (horizontally) all plant marginal cost curves (e.g., MCa
and MCb) to obtain
MCfirm = SMCa+MCb
• Set MR = MCfirm to determine Q* and P*
• Set MCa = MCb = P* to determine Qa* and Qb*
5.8 Producer surplus
• Producer surplus is the difference between the revenue
obtained by the supplier and its full cost of production. It
is a measure of the profitability of supply
• The supply curve shows the seller’s willingness to sell
different product quantities at various prices
5.8 Producer surplus
Price
Supply
Producer Surplus
Quantity
5.9 Multi-product pricing
• Suppliers should consider economies of scope and
advantages of tied sales
• Tied sales - selling goods together rather than separately,
especially complements
• Bundling - selling a package of own products with those
of other firms (eg, an own boat and another firm’s boat
trailer)
5.10 Pricing in Practice
• Mark-up pricing - adding a percentage to the cost
• Price lining - targeting a price or price band to reduce the
cost of marketing and product tailoring to buyers
• Skimming - introducing a new product at an initially high
price to gradually reduce it over time (eg, CD market)
• Prestige pricing - targeting those who judge quality by
price
5.11 Questions for self-assessment
and review
Basic concepts and applications
(1) Define the following
(a) Production function
(b) Marginal product of an input/factor of production
(c) Returns to scale
(d) Economies of scale
(e) Returns to scope
(f)
Diseconomies of scope
(2) What is the difference between economic and business
profits?
(3) What is the difference between the 'short run' and the
'long run' in economics?
5.11 Questions for self-assessment
and review
(4) Why does the 'conventional' supply curve slope upward?
(5) Can you give an example of a flat (horizontal) supply
curve? Why is it flat?
(6) How is the supply schedule related to the supply curve?
(7) What factors determine the quantity of a good that a
seller is willing to supply?
(8) Define (own) price elasticity of supply
(9) Why is the price elasticity of supply likely to be lower in
the short run than in the long run?
(10) What does producer/seller surplus measure?
(11) Draw an illustrative supply curve for:
(a) price taker
(b) price maker
5.11 Questions for self-assessment
and review
(12) What does mark-up pricing involve?
(13) Consider the following production function and fill in the
values for marginal product of labour:
Output
0
10
20
28
35
41
46
Number of
operatives
0
1
2
3
4
5
6
Marginal product
of labour
…
…
…
…
…
…
…
With which operative does diminishing marginal product set
in?
5.11 Questions for self-assessment
and review
(14) Sketch a figure that represents each of the following
situations:
(a) the production function exhibits increasing returns to scale
and diminishing marginal product for both of its two inputs
(b) the production function exhibits constant returns to scale
and constant marginal products for both inputs
Although you do not need to draw the figures to scale, be sure to
label your axes and indicate why your figure illustrates the
situation
(15) Does a change in the technology of making computer
keyboards lead to a movement along or a shift in the supply
of PCs?
(16) What is the price elasticity of supply of 'land' in central
business districts (CBDs) of European capital cities?
5.12 Further reading
Baye (2010): chs. 5 and 7