Economics 310 Price Theory

1. Economics 310Price Theory Production and Cost Homework Department of Economics College of Business and Economics California State University-Northridge Professor Kenneth Ng Monday, October 20, 2014

2. Problem • Read the first three articles about the rebirth of Porsche and answer the following questions. • 1. Use short and long run supply and demand curves to indicate what happened to the market for expensive sports cars in the 1980's and 1990's. Draw Porsche's unit cost curves and depict the how the changes in demand for expensive sports cars effected the short run output decision at Porsche. What was Porsche's logic? • 2. Draw two sets of iso-cost and iso-output curves depicting production and cost conditions at Porsche before and after the arrival of the Japanese consultants. Assume two inputs to the production process--capital and labor. • 3. Use the drawings from (2) to show changes in the marginal cost and average cost curves. Indicate on your graphs the changes in profits/loss after the change in the market from (1) and the changes in the productive process at Porsche described in (2). • Read the other two articles (Automotive News, Autoweek) about the beginning of Porsche production in Finland. • 1. Use iso-cost, iso-output, SRATC, and LRATC to show why Porsche opened a new plant in Finland rather than expanding production in Germany.

3. AVC-Mazda, Nissan, Toyota AVC-Porsche P2 A D 2 The Sports Car Market in the 1980’s The demand for sports cars shifted to the left around 1989. This caused a drop in price. Firms responded in two ways. By shutting down in the short run if the price fell below the min AVC of production and by exiting in the long run. Manufacturers with higher fixed costs and lower variable costs (Japanese firms) were more likely to shut down. Market Firm Price Price ATC S MC 1 Long-run supply P1 P1 P1 D 1 0 Quantity (firm) 0 Q1 Quantity (market)

4. The Sports Car Market in the late 1990’s In the late 1990’s the demand for sports cars has increased (D1 to D3). The price has risen (P1 to P3) and the existing firms (Porsche) have increased output. The existing firms (Porsche) are earning a profit. New firms will enter the market (BMW-Z3, Mercedes-SLK, Honda S-2000, etc.). As the new firms enter, the short run supply curve will shift out (S1 to S3). Market Firm Price Price Profit ATC S MC B 1 P3 P3 S A 3 Long-run supply P1 P1 D 3 D 1 0 Quantity (firm) 0 Q1 Q2 Quantity (market)

5. Capital Labor A B 50,000 Units-before Japanese 50,000 Units-after Japanese Efficient Production at Porsche Under the Craft Culture that prevailed at Porsche before the Japanese, too much labor was used in the production process—inefficient production. Porsche was at point A. The Japanese consultants made two changes, they reduced the amount of labor content (elimination of the fix-it area) and increased productivity by allowing Porsche to produce more cars with the same inputs (Muda elimination and inventory control). The changes are depicted as the movement from A to B. At point B, the ratio of Capital to labor has increased and the iso-output curve for a given amount of production has shifted in. The same output is being produced at a lower total and average cost. 0

6. Costs and Revenue Cost Conditions at Porsche-Japanese The effect of the changes has been to lower the amount of inputs used to produce a given level of output. Since the price of inputs hasn’t changed, this causes a reduction in the unit cost (ATC, AVC and MC) of production and a shift downward of the unit cost curves. MC-Before Japanese MC-After Japanese ATC-Before Japanese AVC-Before Japanese ATC-After Japanese AVC-After Japanese 0 Quantity

7. Capital Labor A Germany Only 100,000 Units 50,000 Units Finland +Germany Expanding Production at Porsche. Porsche is trying to expand output in the short run. The amount of capital is fixed at their German plant. They can only increase output by employing more labor, the variable input (A to B). By opening a new plant in Finland, Porsche can increase the amount of capital and produce the Boxster more efficiently (B to C). 0

8. Exam Notes • No bluebook required. • Calculator recommended.