Supply and Cost

1. Supply and Cost ■ Our objectives:  Explain choices given unlimited wants in the face of limited resources.  Develop a theory that helps us understand what we observe in the world.

2. Cost—always an issue in production (supply).1700: Production of pots in England & China.Why the different technology? Think about cost.

3. Supply chains are now very complicated, so we use a simple model to understand

4. Opportunity Cost The cost of any choice is the best opportunity not taken (sacrificed). Hence we say “opportunity cost.” This can only be known by the individual decision maker. Costs are subjective.  When we measure costs, opportunity cost is the true measure, but we mostly focus on accounting or objective costs. Remember: Costs are never fully known because some are subjective.

5. Put Theory into Practice • “Opportunity cost is the value of the most valuable alternative that must be forgone to undertake a given act. In decision making, we must look at opportunity cost rather than book costs. That is, we must look forward rather than backward.” • Charles G. Koch, CEO Koch Industries, p. 33, “The Science of Success”

6. The (weak) Law of Supply ■ Holding other relevant factors constant, the higher (lower) the price of a good, the greater (smaller) will be the quantity supplied. ▪ Like all scientific propositions, it is a ceteris paribus (“other things equal”) statement ■ Note the terminology: - changes in the price of the good lead to changes in “quantity supplied” - they do not lead to changes in “supply”

7. Foundations ■ The principle of Rising Marginal Cost ► As the rate of production rises in a certain time period, given fixed inputs and technology, at some point the marginal cost of producing the next unit rises ► So, in a market, supply usually reflects the marginal cost (MC) of suppliers as they evaluate their alternatives.

8. We Are All Garbage Men Holding all else constant, the following is true if we survey a group of possible workers: Number of VolunteersPrice Offered 1 $10/hour 2 $20/hour 3 $50/hour 4 $80/hour 5 $200/hour

9. Rising Marginal Cost or Opportunity Cost of Suppliers $ Price 200 MARGINALCOST = SUPPLY 80 50 20 10 1 2 3 4 5 Volunteers per time period

10. The Supply Function ■ S = f (P, I, T, etc.) Price of the good itself—determines the location along the supply curve ■ Other factors—determine the placement of the supply curve: ► Prices of inputs (also called “factor prices”) ► Technology (e.g, state of knowledge; regulations) ► Other variables particular to each good, including weather conditions, etc.

11. Summarize the Supply Curve It represents the valuations of many different existing and potential suppliers in a market, each making their own decision. What is best for me, as I see the world? As I understand my opportunity costs. A simple curve to help us sharpen our thinking about markets.

12. Change in Price • A change in the price of a good means a movement along a given supply curve. Price Supply Pa Pb Quantity/time Qb Qa

13. Caused by: Lower Factor Prices, Improvements in Technology; other changes that lower marginal costs of production. Price Increase in Supply(A Decrease in Supply Is Opposite) Sa Sb Pa Not caused by Change in price Quantity Qb Qa

14. Question on Supply In 1998, DVD players cost almost $1,000. Only a few were sold. Now DVD players cost as little as $30. Why can suppliers provide them at such a lower cost? What else impacted decision to supply and the demand?

15. Opportunity Cost Question: • Suppose average tickets to the Superbowl usually sell for $1,000, but can be resold for about $3,000. Suppose you bought a ticket for $1,000 and can go to the game. • What is the opportunity cost of going to the game?

16. Flat Screen TVs and Movies:Change in One Market Impact Another • Matsushita invested $1 billion+ in a new flat screen TV plant. Production over 2.5 million per year. • Economies of scale allows price to drop while profits increase due to lower per unit cost compared to rivals. Some rivals will die. • Thinking about demand: Increase in bandwidth means cost of delivering movies to a home users falling rapidly. Value of TV changes. [Who will lose markets?]

17. Costs are imperfect but are worth studying for opportunities: Where is the value for the demander? Consider a music CD that retails for $15.99: 24% ($3.83) is retail overhead. 18% ($2.88) is overhead for the label 15% ($2.40) is marketing 11% ($1.76) is label accounting profit 10% ($1.60) is artist royalty 6% ($0.96) is distribution cost 5% ($0.80) is retail accounting profit; 5% manufacturing; 5% publishing accounting royalties What does the consumer want? Any wonder this industry is in turmoil?

18. Book Publishing—Change? The Associate by John Grisham, $27.95 list: $3.55, editors, graphic designer, etc. $2.83, printing costs $2.00, marketing $2.80, wholesaler $4.19, author royalties (high because star author) $12.58, retailer (45% of list); often discounted Room for change? Typical best seller author gets 20%; Amazon offering 45-50%; if self-publish, 75%

19. Supply and Competition Are Increasingly Global Cost of Heart Bypass Operation: U.S.: $130,000 Singapore: $18,500 India: $10,000 Cost of a Hip Replacement: U.S.: $43,000 Thailand: $12,000 India: $9,000 Number of “Medical Tourists” to Thailand: 2000: 500,000 2010: 2,000,000 (33% from U.S.; 29% from China; 18% from Japan; 14% from England)