Chapter Four:

Supply I
Managerial Economics
Lecturer: Chu-Bin Lin
Southwest Jiaotong University

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DRAM Industry, 1996-98
Prices fell sharply
Fujitsu closed Durham, UK, factory but
continued production at Gresham, OR
Texas Instruments (TI) sold Richardson TX,
Italy, and Singapore plants to Micron
TI shut Midland, TX plant

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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?

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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

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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

 Difference between short and long run depends on

past commitments

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Short-Run Cost
 Analyze total cost into two categories
 Fixed cost (F)– does not vary with production
scale
 Variable cost (V) – does vary
 Total cost, C = F + V

 Marginal cost (MC) = increase in total cost for

production of additional unit
 Average (unit) cost = total cost / production rate

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Short-Run Weekly Expenses

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Analysis of Short-Run Costs

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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

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Short-Run Total Cost

total cost= variable cost curve

Cost (Thousand $)

8 shifted up by fixed cost

6 variable cost

2
fixed cost
0 2 4 6 8

Production rate (Thousand dozens a week)

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Short-run costs
Marginal cost: change in total cost due to production
of additional unit
Average (unit) cost: total cost divided by production
rate
Algebraically,
C F V
 
q
 q
 q

average cost average fixed cost average variable cost

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Diminishing Marginal
product
Marginal product: increase in output from
additional unit of input (the input can be
equipment, labor, or material).
Diminishing marginal product: marginal
product reduces with each additional unit of
input

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Short-Run Marginal, Average Variable,
and Average Costs
Cost (Cents per dozen)

Diminishing marginal product

300
causes marginal and average
250 cost curves to rise
200
150 marginal cost
average cost
100
50 average variable cost

0 2 4 6 8
Production rate (Thousand dozens a week)

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Short-run individual supply
Two key business decisions:
◦ Participation: Whether to continue in business
(break even)?
◦ Extent: If continue, what scale of operation?
Example:
◦ Whether to open a new store?
◦ Whether to extending operating hours to 9pm?

We answer the second question first.

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Marginal revenue
Total revenue = price x sales quantity.
Marginal revenue: change in total revenue
from selling additional unit
◦ If price is fixed, then marginal revenue is
equal to price

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 Short-Run Profit, I
Table 4.3 Short-run profit
Weekly Variable Total Total Accounting Economic Marg. Marg.
prodn cost cost revenue profit profit cost revenue
rate
0 $0 $22,000 $0 ($22,000) $0
1,000 $4,290 $26,290 $7,000 ($19,290) $2,710 $4.29 $7.00
2,000 $8,360 $30,360 $14,000 ($16,360) $5,640 $4.07 $7.00
3,000 $13,160 $35,160 $21,000 ($14,160) $7,840 $4.80 $7.00
4,000 $18,970 $40,970 $28,000 ($12,970) $9,030 $5.81 $7.00
5,000 $25,930 $47,930 $35,000 ($12,930) $9,070 $6.96 $7.00
6,000 $34,150 $56,150 $42,000 ($14,150) $7,850 $8.22 $7.00
7,000 $43,700 $65,700 $49,000 ($16,700) $5,300 $9.55 $7.00
8,000 $54,620 $76,620 $56,000 ($20,620) $1,380 $10.92 $7.00
9,000 $66,960 $88,960 $63,000 ($25,960) ($3,960) $12.34 $7.00

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 Short-Run Profit, II

47.93
12, 930
35

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Short-Run Profit, III
Profit-maximizing (loss-minimizing)
production rate: where marginal revenue
equals marginal cost;
• if marginal revenue > marginal cost,
increase production
• if marginal revenue < marginal cost,
reduce production

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Short-run individual supply

Produce where marginal cost = price

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Short-Run Breakeven
Continue to produce if
Total revenue >= Variable cost, or
Price >= Average variable cost

Proof:
Shutting down payoff: −𝐹
Continuing production payoff: R − 𝑉 − 𝐹
You are willing to continue if R − 𝑉 − 𝐹 ≥ −𝐹
𝑅 𝑉
R ≥ 𝑉, or ≥
𝑞 𝑞
𝑉
p≥
𝑞

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Short-Run Breakeven
Sunk cost: cost that has been committed and
cannot be avoided.
(1) Sunk costs should be ignored in making a
current decision
(2) Assume, for competitive markets analysis,
fixed cost = sunk cost

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Short-Run Breakeven
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.

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Short-Run Decision Summary
(1) If the total revenue cover the variable
cost, producing at the rate where the
marginal cost equals the price;

(2) If the total revenue does not cover the

variable cost, shutting down.

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Short-Run Supply Curve
Individual supply curve: Graph showing quantity
that seller will supply at every possible price
For every possible price, find quantity for which
marginal revenue = marginal cost

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.

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Short-run individual supply:
Input demand
Change in input price
◦ shift in marginal cost
◦ change in profit-maximizing production

Ex. Lower wages

Lower costs on material

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Short-run individual supply:
Input demand

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Questions
1. What would happen if there is a higher
input price?

2. How should the slope of a supply curve be?

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