LGT 5007 Shipping Economics

and Markets
3: Shipping Supply

1
 Learning outcomes
Students are expected to understand:
1. Fundamental concepts in production process
2. Cost function
3. Supply function for ships
4. Determinants of shipping supply

2
 Introduction
Supply and shipping supply
• Supply is how many/much to sell at what price.
– Production technology and management
– Cost of production
• Sea transportation is the core business in
shipping industry
– Supply function for individual ship
– Determinants of shipping supply
• What are the inputs for shipping?

3
Example: Inputs for Sea Transportation and cost categories
Operating costs
• Crew
• Stores & Voyage costs Cargo handling
Lubricants •Fuel •Cargo type
• Repairs & •Speed •Ship design
Maintenance •Port charges •Cargo-handling gear
• Insurance •Canal dues •Unitization of cargo
• Administration •Tugs, etc •Organization
•Stevedore costs

Profit
Revenue

Capital/financial cost Periodical Tax/dividends

•Source of capital/loan Maintenance
•Size & length of loan •Age of ship
•Interest rate •Maintenance policy
•Currency •Special survey cycle
•Regulations

4
 Generalization
Shipping Port
• L: Captains, deck crew, • L: Yard workers, gate
engineering crew, shore operator, office
Inputs

office workers workers, …

• K: Ships and onboard • K: Terminal space,
equipment, cranes, storage room, …
• M: Fuel, fresh water, • M: Electricity, office
other supplies suppliers, maintenance
consumables, …
Output

Q: Ton-miles of cargo Q: Tons of cargo

carried load/unloaded
5
 Production Isoquants
• Same level of output 𝑄Q11 < Q𝑄22 <
Q3𝑄3
K
can be produced by
different combination 𝐾1 1

of inputs—Production 𝐾3 3
Technology
• Different inputs
2
combinations that 𝐾2

generate the same level

of output called 𝐿1 𝐿3 𝐿2 L

Production Isoquant
6
 Two unique types of Isoquants
X X

Q3
Q2
Q1 Q2 Q3 Q1

Y Y
Implications for economic analysis: Implications for economic analysis:
• The reduction in one input can always • These two inputs have to be combined
be substituted by the increase of the in fixed proportion.
other. • You group them together
• You select one of them based on their Examples?
relative prices.
Examples?
7
 Time frame of a production function
• Short run Production • Long run production
function function
Refers to a time frame The time frame where all
where the quantity of one the input can change.
or two inputs cannot be • Implications
changed. You can select an optimal
• Implications production scale—reduce
You cannot adjust such costs/maximize output.
inputs to reduce cost, or
increase output.

8
 Productivity Measures for single input
• Average Production (AP) of Labor
• Marginal Production (MP) of Labor
AP: The average number of products M’
can be produced by each unit of MP: The slop
labor over the whole range of line MM’
Q
O’ Q = f ( L, K )
Q
APL = M

L
MP: The number of products can be
produced with one more unit of labor

AP: The slop

of line OO’
Q
MPL =
L O L

9
 Marginal Rate of Technical Substitution
K

Diminishing …
K MPL 3 A
MRTS = − =
L MPK
2 B
Isoquant curve (Q=100)

c
1

0.8 1 2 L

When many units of an input are used, it is easy to replace one unit of such input
with others.

10
 Return to scale (RTS)
• Measures whether proportional increase in all
inputs will bring up the same proportion in
output.
– If there are equal, called constant RTS;
– If out increase proportion is smaller, it is
decreasing RTS;
– Otherwise, it’s increasing RTS.

Importance: Whether to expand the production scale?

11
 Increasing Return to Scale

Capital

Q=200

Q=100

2 4 Labor
12
 Figure 2. Constant Returns to Scale
Constant Return to Scale
Capital

4
Q=200

Q=100

2 4 Labor
13
 Decreasing Return to Scale
Capital

4 Q=200

Q=100

2 4 Labor
14
 Cost equation & cost function
• Cost equation: How total cost is calculated
based on various inputs and their respective
prices.
– It has no information on the output quantity, nor
whether the inputs combination is optimal.
𝐶 = 𝑟𝐾 + 𝑤𝐿
• Cost function: The minimum cost required for
certain output.
– It implies the quantity of inputs are optimized.
𝐶 = 𝐶(𝑄)

15
 Production function to cost function
• For every output level, the
K Q=f(K, L)
producer will figure out the way to
𝐶2 produce it at minimum cost.
𝑟

𝐶1
𝑟

𝐶2 𝑤
𝐾= − 𝐿
𝑟 𝑟

𝐶1 𝑤
𝐾= − 𝐿
𝑟 𝑟

16
 If we look at the minimum cost to produce different output

K
𝐶
𝐶3 𝐶(𝑄)
𝑟
𝐶3
𝐶2
𝑟 𝐶2
𝐶1
𝑟 𝐶1

𝑄3
𝑄1 𝑄2 𝑄3 𝑄
𝑄2
𝑄1
L

17
 Typical long-run cost function
• High initial cost: if you set up
a factory, you need a site, a C($) LTC
building, several different
kinds of equipment, offices,
and certain number of people C
to start with.
• After that and within the C(Q)
C*
production capacity, the cost
increase slowly with output.
• If the production reached its
capacity, further increase
require OT, or additional Q* Q
equipment, etc., so cost will
increase fast.
18
Short-run cost function
C($) Total Cost
C(Q)+C0

C*
Variable cost C(Q)

Fixed Cost C0

19
From Cost function to Average Cost and Marginal Cost
𝑀𝐶 = 𝐶 ′ (𝑄) 𝐶(𝑄)
$ C=C(Q) 𝐴𝐶 =
𝑄

20
Bookwarm’s definition of supply curve
$
MC

P Economic rent
AC

P0

Q output

Supply function is the marginal cost function where marginal cost

is larger than the average cost.

21
 Carriers’ decision in short run and
long run
• In competitive shipping market, carriers take
market price as given, and maximize the profit
by set marginal cost equal to the freight rate.
• In some cases, even the freight rate is lower
than its total average cost, it still keep running
the service.

22
 Supply function for one ship
$225

Freight rate $ per million ton miles

Supply increases as
the ship speeds up

Max speed 15 knots

$200

Ship supply
$175 function

$150 Minimum speed 11 knots D

C
A B

11kts 15kts
Billion ton-miles per annum
A. Not economic to put the ship into use, because demand is too low.
B. Ship is not fully loaded, the marginal cost to increase the quantity shipped is
very low.
C. Demand is high, most of the time, the ship is fully loaded. To supply
additional service, high speed is required. This will boost the cost.
D. The demand is too high, the ship simply cannot handle so many cargo, even
with maximum speed all the time. More vessel is needed.
23
 Increase the use of ships in one company
k=1 2 4 5 n
$225
Freight rate $ per million tome miles

qs=f(p, k, poil, w, X)
$200

$175

$150 Minimum speed 11 knots

11kts Billion ton-miles per annum

Aggregated supply for the company with n vessels is the outer envelope of all
the individual vessels’ supply curve. This is also the long-run supply curve for all
the vessels.

24
1,000 Market Supply
900
800
Total world cargo fleet (m DWT) and age distribution
700
600
500
400
300
200
100
0
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Bulker Container Crude Tanker

70%

60%
World shipping capacity is the
50%
best measure for shipping supply.
40%
Capacity changes with new
30%
order/demolition
20%
Shipping supply changes with
10%
many other factors.
0%
>30 20-30 10-20 0-10

Tankers Bulk Container

25
Factors affecting the supply of individual carrier
• The capital and financial costs of its fleet.
• Input costs: fuel, labor
• Second-hand market, Chartering market,
demolition market
• Cooperative agreement
– Liner services used to operate in conferences,
consortia, etc, that have high market power.
– In the 80s-90s, anti-trust/competition laws in USA
and EU have banned their rate setting behaviors.
– Now, only the VSA are allowed, need approvals.
26
 Alliance reshuffles
1996
2017

27