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[M] Advanced Business Management Economics

by: Maurine Kuhic

[M] Advanced Business Management Economics EconS 452

Marketplace > Washington State University > Economic Sciences > EconS 452 > M Advanced Business Management Economics
Maurine Kuhic
GPA 3.58

Thomas Marsh

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Thomas Marsh
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This 30 page Class Notes was uploaded by Maurine Kuhic on Thursday September 17, 2015. The Class Notes belongs to EconS 452 at Washington State University taught by Thomas Marsh in Fall. Since its upload, it has received 77 views. For similar materials see /class/205980/econs-452-washington-state-university in Economic Sciences at Washington State University.

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Date Created: 09/17/15
ONS 452 Advanced Bus39ness Management Eoonomios Lectures 1718 ame Theory Overview Introduction to Game Theory neousMove OneShot Games Repeated Gam IV Fi ely Repeated Games V Multistage Game Game Environments Players planned decisions are called strategies Payoffs to players are the pro ts or losses resulting from strategies order of play is important Simultaneousmove arne each player makes decisions without knowledge other players decisions ve game one player observes its rivals a egy neshot game game is played once Repeated arne game is la ed more than once either a nite or i lnite number i eractions SimultaneousMove OneShot Games Normal Form Game A Normal Form Game consists f Set players is 1 2 n where n is a er h players strategy set or feasible 39 consist of a nite number of strategies Payer1 strategies are s Player 2 s strategies are s2 Payoffs Player 1 s payoff was 11 L 39 12 n 9 S m A Normal Form Game Player 2 Player 1 Player 1 un na n Normal Form Game Scenario Analysis I Suppose1 thinks 2 will choose A Player 2 11 1 r I Normal Form Game Scenario Analysis IThen 1 should choose quotaquot I Player 1 s best response to quotAquot is ra PlayerZ strategy Player 1 Player 1 Normal Form Game Scenario Analysis I Suppose1 thinks 2 will choose B Pl ayer 2 ll Player 1 W Normal Form Game Scenario Analysis I Then 1 should choose quotaquot Player 1 s best response to quotBquot is quotaquot PlayerZ m Player 1 Normal Form Game Scenario Analysis I Similarly in thinks 2 will choose C Player 1 s best response to quotCquot is quotaquot PlayerZ I Player 1 Dominant Strategy Regardless ofwhetherPlayerZ chooses A a or my a 1 is better off choos aquot a is Playerl s Dominant strategy previous game Dominant Strategy in a SimultaneousMove OneShot Game I A dominant strategy is a strategy resulting in the highest payoff regardless of the opp I lfquotaquot is a dominant strategy for Player 1 in the then 39 1arAgt 1hrA2 ilcrAli 39 1MB gt 151013 15103 and n1aCgt n1hC 2 mop onent s action Putting Yourself in your Rival s Shoes I What should player 2 do 2 has no dominant strateg But 2 should reason that1 will play aquot Therefore 2 should choose C PlayerZ I Player 1 6 1015 1013 1314 Pl ayer 1 The Outcome PlayerZ I I Thls outcome is called a Nash equilibrium a is player 1 s best response to C quotCquot is player 2 s best response to a TwoPlayer Nash Equilibrium I The Nash equilibrium is a condition describing the set of strat 39 ic no la r can improve her payoff by unilaterally changing her own strategy given the other player s strategy I Formally 11s1 s2 2 11s1s2 for all s1 39 M51352 2 falShSzl f r 3quot 52 Key Insights I Look for dominant strategies I Put yourself in your rival39s shoes ONS 452 Advance Bus39 Manag Lectures 56 Individual Behavior ness ement Economics 0 Overview Background Preferences Consumer s Problem Background Consumeropportuni39 osslble goods and services consumer can afford c nsume ConsumerPre The goods Indifference Curves can Indifference Curve m A curve that de nes the combinations of2 or more I goods that give a consumer ferences the same level of and services consumers actually consume satisfaction Giventhe choice between 2 bundles of go Marginal Rate ofsubstitution consumer either The rate at which a consumer is vvillingto 4 substitute one good for 39 39 another and maintainthe caaux ls indifferent betweenthe two A B same satisfaction lever Consumer Preference Ordering Properties Completeness More IS Better Diminishing Marginal Rate of Substitution Transitivity I Completeness Pro erty Consumer is capable of expre 39 or indifference be all pos don t k opt39 lflhe any bundles In a cansumera h can sslng preferences tween sible bundles I nowquot is NOT an Ion39 availahle re A a and wi codex meter is In c Bundl that n as may rnucn uleyery good and rnure ul nd a p elerred ll Bundle 3 rsalsu rimmed In c snoe a mmans a leasl as nucn mnnnd x and gnaw rmre m and v Mme dmerally all bundles an IC m are married In bundles an IC nr lc And all bundles an IC are preterm In lc Gmx Marginal Rate ul Sulrsliluliun rne mum at nndvlhe mnsurmr lsw no In dive ur In rmInIzn Ihe sane sarsanurn levu decreases as rmre M nnd x Is ac ulrm the meat which a mnsrrner Is wrllrnd In sinsnlule une duud lur mmner md manlan Ihe sane salrsauurn Isl In dul mnmmr llnn hundle A us up an nal unu caddy mm In a the cunsumer rn unus MYID as one add n 5H m x lngn39mm mnslmrmnn hundle a z 33 In the cunsumerrnus dive un 25 ism unusulvtu as one addmunal unu at x lngn39mm mnsrmrmun hundleC In the cunsumer mus Ive up on rm unus MYID I one addurunal unit at x I Tra e Forthe three bundles A Gmquot la and c the transitivity property implies that if c gtEand EgtAthen c Transitive preferences along with the moreis etter property imply that erence curves will not men Ihe cunsurnerwill nnl gel caught aperpelual cycle Mindeclslnn I Opportunity Set The set of consumption bundles that are affordable Y m szwmmy m BudgetLInz YWPYCPx PyX 39 The bundles of goods that exhaust a c nsumers ome PXX P v M 39 Market Rate of Substitution Slope of the budget line PX I Py Consumer Optimization Problem r233 uXYz subjecttopxxgng IFuXY Z 7r Mrng PYY 191A i7ru i if W euvn 81 Y EMeaxemeu 81 Consumer Optimization Problem Solve rst nrder cundmnns tn nlztam demand funcdnns X Maximo YfyltIiIiMzgt Hence demand fur gnndsX Yare tuncunns nfpnce an pnce an1nnmeMand demand shl er z GaudX Marginal Rate of Substitution Cnnslder uXYu andtake the total differential lasidy W 7 ex BY W 3461 The absnlute value while slnpe nfthe mdlffermce curve is the marginal rate of subsuruuun MRS MEX BIABY me the eunsumer39s problem then MRS I Decrease Increases ead paraIIeI outward shirtin we the budget Iine M1 gt MD s lead to a parallel downward shirt M lt M c A decreases in the price of goo rotates the dX cIockwise D M An increases rotates the budgetIinecIockwise notshown y Changes in Income WK I we 2 u Changes in P 39 e M W Mir NM my lamor a pma memos XgtP The equilibrium consumption bundle is the affordable bundle that yields the highest level of satisfaction Consum er equilibrium occurs at a point where MRS IgtX I IgtV Equivalently the sIopeor the indifference curve equals the budget Iine I Substitute Goods An Increase de X lea s to a n Example Coke s and Pepsi Verizon Wireless orATampT rice of good crease in the p rea se in the c se decrea f good V 9 PretzelsCI Whm map goodXuns and m 9 we m u Eeeroz I Normal Goods Good X is a no decrease in income leads to an increase decrease in its consumption I Inferior Goo Good Xi ds s an inferior good if an increase decrease in income increase rmal good if an increase eads to a decrease consumpti n ecomposing the Income and Substi Normal Goods cts v v Am em ZZZSZZSSZ M W W nwmuigaods mquot membmm one m 51 Mimi cusmmain m w gym IE m mw Eqwbbrmm is achievedntpomt c An individual s demand curve is derived from each new equilibrium point found on the indifference cu ve as a x the price ofgood x is varied The market demand curve is the horizontal sum Ill ation of individual dem an 3993 Conclusion it indicates thet ai quantity aii consumerswouid indifference curve properties reveai information about mm a m quot9 p 39quotquot consumers preferences between bundles of goods Completeness s inawaiaioma s Mayoimmau cm More is bet om 5n ter Diminishing marginal rate ofsubstitution Tr nsitivity Indifference curves along with price changes determine individuals demand curves Market demand is the horizontal summation ofindividuals Q demands Q i 2 z agement Economics tures 1314 et Structure amp Management Overview I Perfect Competition I Characteristics and pro t outlook I Effect of new entrants ll Monopolies I Sources of monopoly power I Maximizing monopoly pro ts I Long run equilibrium Perfect Competition Environment I Many buyers and sellers I Homogeneous identical Key Implications product I Perfect information on both sides of market I No transaction costs I Firms are price takersquot P MR I In the shortrun rms may earn pro ts or losses I Entry and exit forces longrun pro ts to zero I Free entry and exit Unrealistic Why Learn mall businesses are pricetakersquot and decision rules for such rms are similar to those ofperfectly competitive irms m x 0 139 z m lt in o lt o nments oppose monopolies Illuminates the danger to managers ofcompetitive environments I Importance of produ ct differentiation I Sustainable advantage Managing a Perfectly Competitive or PriceTaking Business lrm Setting Price is 55 VS ADM Market Firm Graphically Representative Firm s Output Decision Pro t Pe ATC x Q ProfitMaximizing Output Decision MR MC Since MR P Set P MC to maximize pro ts Given P10 CQ 5 02 Optimal Price P10 Optimal Output MRP10and MCZQ 10 2Q I Q 5 units Maximum Pro ts Should this Firm Sustain Short Run Losses or Shut Down Pro t Pe ATC x Qfquotlt 0 pe PeDfMR Q Q PQ CQ 105 5 25 20 Shutdown Decision Rule A pro tmaximizing rm should continue to operate sustain shortrun losses if its operating loss is less than its fixed costs Operating results in a smaller loss than ceasing operations Decision rule A rm should shutdown when P lt min AVC Continue operating as long as P 2 min ShortRun Market Supply Curve e arket supply curve is the summation of each individual rm s supply at each price Firm s ShortRun Supply Curve MC Above Min AVC Th PmAVC Long Run Adjustments I If rms are price takers but there are barriers to x s x en pro ts will persist m 5 I If the industry is perfectly competitive rms are P D not only price takers but there is free entry P l w I Other greedy capitalistsquot enter the market D Q Q Market Fm Effect of Entry on the Firm s Summary of Logic Output and Pro ts MC I Short run pro ts leads to entry I Entry increases market supply drives down the market price increases the market quantity I Demand for individual rm s product shifts down I Firm reduces output to maximize pro t I Long run pro ts are zero Features of Long Run Competitive Equilibrium P MC I Socially el cient output I P rn nim rn AC I El cient plant size I Zero Firms are earningjust enough to offsettheir opportunity cost Monopoly Environment I Single rm serves the relevant marketquot I Most monopolies are local monopolies I The demand for the rm s product is the market demand curve I Firm has control over price I But the price charged affects the quantity demanded of the monopolist s product Natural Sources of Monopoly Power I Economies of scale I I Economies of scope I Cost complementarities Managing a Monopoly I Market power permits you to price above MC I Is the sky the limit I I No ow muc you sell depends on the price you set Created Sources of Monopoly Power I Patents and other legal barriers like licenses I Tying contracts I Exclusive contracts I Collusion Monopoly Profit Maximization PmducewhzreW Chargethe price on MC m demandcurve lhatcan39espondsta lhatqummy Alternative Profit Com putation 7r Total Revenue rTotal Cost 7 PerTotalCost L PerTotal Cost Q P Total Cost I role 0 H PrATC 3ft PrATCQ Useful Formulae s e MRifa rm faces alinear demand curve for its product P a bQ MR a 2bQwz272 17 lt 0 Alternatively MRp E I Given estimates of P 10 Q 39 CQ 6 251 I Optimal output 10 Q 10 2 2 Q 4 units I Optimal price P 10 A 6 I Maximum pro ts PQ CQ 6 6 3 10 Long Run Adjustments I None unless the source of monopoly power is eliminated Why Government Dislikes Monopoly I PgtMC Too little oLt Lt attoo hih a price Deadweight loss of monopoly Deadweight Loss of Monopoly Arguments for Monopoly I The henef ial effects of e nomies of scale economies of scope and st complementarities on price and output may outweigh the negative effects of market power I Encourages innovation co co Monopoly MultiPlant Decisions Consider a monopolythat produces identica output at two production facilities think of a rm that generates and distributes electricity from two facilities I Let 010 he the production cost at facili I Let 020 he the production cost at facility 2 39 Decision Rule Produce ompm where W0M3v012quotd Wm W10z Set price equal In Pm where a a o 01 ompet n Environment and Implications I Numerous buyers and sellers I Differentiated products I Implication Since products are differentiated each rm faces a downward sloping demand curve Consumers view differentiated products as close substitutes there exists some willingness to substitme I Free entry and exit I Implication Firms will earn zero profits in the long run Managing a Monopolistically etitive F39rm Like a monopoly monopoiisticaiiy competitive rms have market owerthat ermits ricin above margina co ievei ofsales depends on the price it sets The presence of other brands in the market makes the demand for your brand more elastic than if u were a monopolist Free entry and exit impacts pro tabi 39 y Therefore monopoiisticaiiy competitive firms Marginal Revenue Like a Monopolist Monopolistic Competition Profit Maximization ShortRun Monopolistic Competition M 39ze ro ts like a mono olist I Produce output whe I Charge the price on the demand curve that corresponds to that quantity Long Run Adjustments Long Run Monopolistio Competition langRunEqiiilihnum If th dustry is truly monopolis ically competitive t P Acvm mi m 39s there is free ent I In this case other greedy cap alistsquot enter and their new brands steal market sh re I This reduces the demand for your product until pro ts are ultimately zero Monopolistic Com petition The Guud Tu Consumers Optimal Advertising Decisions Advertising is one way forfirms with market powerto 7 differentiate their prod cts product Variety But how much should Pgt MC Excess capac39 u 39 pend on advertising Adverti e tothe point where the additional revenue generated from advertising equals the additional cost of advertisin 39 the pro tmaximizing level of vertising occurs where e adve i 39ngtosales ratio equals the ratio ofthe advertising elasticity of demand to the ownprice elasticity ofdemand va neelulled emnnrrles m sme 7 East Ea Maximizing Profits A Synthesizing Example Marginal Cost cm 125 402 So MC so I This is independent of market structure Clo 125 402 39 I Determine the pro tmaximizing output and price and discuss its implications if I ou are a Ice taker and other rms charge 40 per unit I You are a monopolist and the inverse demand for your product is P 100 0 I You are a m i i y compet e rm and the inverse demand for your brand ls P 100 0 Price Taker MonopolyMonopolistic Competition I MR 100 2Qsince P 100 Q I SetMRMCor1002 8Q ou I Cost of producing 5 units 39 CQ125 4Q2125 111 225 90 I Revenues P0 405 200 I Maximum pro ts of 25 I Implications Expect exit in the longrun Monopolistwill not face entry unless patent or other entry barriers are eliminated Monopolistically competitive rm should expect other rms to clone so pro ts will decline overtime Conclusion the m Produce output where P Firms may earn pro ts or losses in the short run but in the long run entry or exitforces pro ts to zero A monopoly rm in contrast can earn persistent pro ts provided that source of monopoly power is not Firms operating in a perfectly competitive market take arket pr39ce as given A rnonopolistically competitive rm can earn pro ts in the short run but entry by competing brands will erode these pro ts over time CONS 452 Advanced Bus39 5 Manag Lectures 1516 Oligopoly nes ement Economics Overview I Conditions fo 0 r gopoly ll Role of Strategic Interdependence Ill Pro t Maxi Settin Four Oligopoly s Sweezy KinkedDemand Model d tMo el Stackelherg Model Bertrand Mo el IV Contestahle Markets Oligopoly Environment Relatively Duopoly Triopoly three rms The products rms offer can be either differentiated or homogeneous rew rms usually less than 10 two rms Ir l decisions impact one another Many different strategic variables are modeled No single oligopoly model Role of Strategic Interaction I Vour actions affect the pro ts of your rivals I Vour rivals39 actions An Example I Vou and another rm sell differentiated products run your pruuuu change when you change your price 1 D2 Rival matches your pncc change Pc Pquot Pl i i l l Rival holds its 3 i once constant I Qm QanQu Qu D2 Raw matuhes wlx pnce change Demand fowalsttcthce Reducnans but not Pnce Increases D1 Rural hnldsns pnce canan Key Insig ht The effect ofa price reduction on the quantity dern anded ofyour product depends upon whether your rivals respond by cutting their prices too The effect ofa price increase on the quantity dern anded ofyour product depends upon whether your rivals respond by raising their prices 00 strategic interdependence You aren t in complete c n rol ofyour own destiny Sweezy KinkedDemand Model Environment Few rms in the market serving many consumers Firms produce differentiated produc s Barriers to entry Each rm believes rivals will match orfollow price reductions but won t match orfollow price increases Key feature ofsweezy Model I Pricengld ty Sweezy Demand and Marginal Revenue D1Rml matches yourpnce change D Sweezynemand Da naval hale Its pace mustard Mn SweezyMR Qquot Sweezy Pro tMaximizing Decision D1Rlwl matches your pace change Sweezy Oligopoly Summary I Firms believe rivals match price cuts but not price increases I Firms operating in a Sweezy oligopoly maximize pro t by producing where The kinkedshaped marginal revenue curve implies that there exists a ran e over which e MC will not impact the pro t zlng level of output Therefore the rm may have no incentive to change price provided that marginal cost Cournot Model Environment Afew firms produce goods that are either perfect substitutes homogeneous or imperfect substitutes differentiated 39 Firrns control variable is output in contrast to price rm believes theirrivals will hold output constant if it changes its ow put e output of ivals is viewed as given or fixed Barriers to entry exist Inverse Demand in a Cournot Duopoly Market demand in a homogeneousproduct Cournot duo oi is p Y PaabQiQz Thus each rm s marginal revenue depends on the output produced by the otherfirm Moreform ally sz 2bQi bQi 25 MR 7 MR 2 BestRes ponse Function Since a rm s marginal revenue in a homogeneous Cournot oligopoly depends on both its output and its rivals each firm needs a way to respond to rival s output ecisions Firm is best response or reaction function is a schedule summarizing the amount of a rm 1 should produce in orderto maximize its profits for each quantity of 12 produced by firm 2 Since the products are substitutes an increase in firm 2 s output leads to a decrease in the profit maximizing amount offirm 1 s product BestResponse Function for a Cournot Duopoly To find a rm s best response function equate its marginal revenue to marginal cost and solve for its output as a function ofits rival s output Firm is best response function is c is firm 1 s MC Qieerz 25 292 39 Firm 2 s bestresponse function is 2 is rm Ts MC l QxnQ 2b 79 Graph of Firm 1 s BestResponse Function Q2 HQb Q Q1 mom 7 uso r Firm is Reztl39nn micami Cournot Eq brium 39 Situation Where each firm produces the output t at maximizes its profits given the the output of rival rms No firm can gain byunilaterally changing its own output to improve its profit A point where the two rms best response functions intersect Summary of Cournot Equilibrium Graph of Cournot Equl brium I The output 01 maximizes rm 1 s pro ts given that rm 2 produces 02 I The output 02 maximizes rm 2 s pro ts given that rm 1 produces 01 I Neither rm has an incentive to change its output given the output of the rival I Beliefs are consi t nt I e In hriu ach rm quotthinksquot rivals will stick to their current output and do Firm 1395 ISC39F39m t curve Another Look at Cournot Decisions Q2 llziilm inns nlnulpuls nllhetwn rms rm 1 the same level nl prn l Fm rebeexeepmsesz39 Q2 Q2 Fmrspmms ammmmemm rm 139s mm ms me Q ommmhmm Q2 quot QZ Cm malequdlbnnmpnw m rm 139s marginal cost increase Qz39 M Collusion lnoentiv Oligopoly es in Cournot Stackelberg Model Environment Few firms sewing many consume s Firms produce differentiated orhomogeneous products I Barriers to en 39 Firm one is the Th ader co all other lrms eader mmits to an output before s are foll Wers They cho e their outputs s s to maximize pro ts given the leader s nutnut Stackelberg Equilibrium Q1 Stackzlhexg mumm ii The Algebra of the Stackelberg Model Sincethefollower reacts to the leader s output the followers output is determined by its reaction function a C Q Mgr Zb 0 SQl elherg leader uses this reaction function to determine its profit maximizing output leve which simpli es to I The Stack a c2 7 2c 2b I Stackelherg model ill c mmi ment can enh strategic L Barriers to entry exist Consumers enjoy I Perfect information I F r produces less than the Cournot 39 Z r quotamacmquot Sts39 eq hrium output Smaller Inwer profits market sh Firstmover advantag I Stackelberg Summary ustrates how ance pro ts in environments out I Leader produces more than the Cournot equilibrium arger are higher pro ts e Bertrand Model Environment I Few rms that sell to many consu Firms produce identical products at marginal cost I Each rm independently sets its price in orderto maximize pro s price is each rms control variable ers constant Bertrand Equilibrium Firms set P1 P2 MC Why Suppose MC lt lgt1 lt 2 Firm 1 eams P1 MC inn 2 eams nothing Firm 2 has a 1 5 price to on each unit sold while n incentive to slightly undercut firm capture the entire market has an incentive to undercut rm price This undercutting continues Equilibrium Each rm charges P1 P2 MC Contestable Markets Key Assumptions Pr r a e o a etechnology Consumers respond quickly to price changes zlt oo 2 o 5 in o Key implications ofentry disciplines rms already in the mar et incumbents have no market pow er even if there is only a single incumbent a monopolist Conclusion Different oligopoly scenarios gi e rise to different optimal strategies and different utcomes You optimal price and output depends on Beliefs a out the reactions of rivals Vour choice variable P or Q and the na et differentiated or homogeneous products oura ty 0 credibly commit prior 0 your rivals E In 399 o a 9 E n ONS 452 Advanced Bus39ness Management Economics Lectures 78 FinnIndustry I Production Analysis Total Product Marginal Product Average n ll Cost Analys Total Cost Variable Cost Fixed Costs Cubic Cost Function n o 2 in E 3 S m Ill MultiProduct Cost Functions Production Analysis Production Function F K o is quantity of outputproduced K is capital input ut F is afunctional form relatingthe inputs to output The maximum amount of output that can he produced with K units of capital and L units of labor ShortRun vs LongRun Decisions Fixed vs Variable Inputs 39Production Function Algebraic Forms Linear production function inputs are perfect substitutes Q FKL aK bL Leontief production function inputs are used in fixed proportions Q FKL minbKcL CobbDouglas production function inputs have a degree of substitutability QFKLK Productivity Measures Total Pro Total Product TP maximum output produced with given amounts of inputs Example CobbDouglas Production Function Q FKL K5L5 K is fixed at 16 units snort run CobbDouglass production function 16 5L5 4 L5 Total Product when 100 units oflabor are used a a 11 j mm an units Productivity Measures Average Product of an Input Average Product of an input measure of output produced per unit ofinput I verage Product of Labor APL QIL Measures the output of an veragequot worker Exaiii F KL K5L5 puts areK16 andL lahnrisAPtl16quot l16quot 16 I Average Product of Capital APK QIK Measures the output of an average unit of capital Exaiiip FKL K5L5 lithe 6then the average product nl puts areK 16 and L s then the average product M s APK 116quot 116quot 1 lithe cap W I Produ 39ng on the product39on function ort I Employing th W short run to aximize ro It a manager will hire hor until capital until the Marginal Rate of Technical Substitution MRTS e rate at which two inputs are substituted while maintaining the same output level Productivity Measures Marginal duct of an Input Marginal Product on an lnput change intotal output attributable to the last unit of an input Marginal Pro uct L AQ AL Measures the output produced by the last worker slope ofthe sh rtrun productionf ncuon Mm respect labor Marginal Product of Capital MPK AQIAK Measures the output produced by the last unit of ca Ital When capital IS allowed to vary Inthe short run MlK IS the slope ofthe production function with respectoo capitall Increasing Diminishing and Negative Marginal Returns Guiding the Production Process ng incentives to induce maximum worker e right level of inputs al vary in the the value of marginal product of labor eguals e wage lMPL w where lMPL P x mm value orrnarginal product of capital guals the rental rate lMPK r w ereVMPKPxMPK lsoquant I Illustrates the longrun combinations of inputs K L that yield the producer the same level of o p t I The shape of an isoquant re ects the ease with which a producer can s i u uhs mong inputs while maintaining the same level of output WTSKLMPL I Capital and Iahorare perfect substitutes I Q K I M L bla Linear isoguants imply that inputs are substituted at a constant rate independent ofthe input levels employed Leontief lsoquants Capilalandlahnrarepe e K armylaments Cap al and lahnrareused in Q xedrprnpnrlinns Q i Q 01 lmmmg 0m EU c2 can al and lahnrare cnnsumed Ixed prnpn nns there is nn Inpulsuhslilullnn alnng ianuants hence nn MRTSN Inputs are nnl pervech suhsl ulahle usl he emplnyed m prnduce the same nulpul level KlLb MRTS MIAMPK NM 5005 am The cnm ns nlinpulslhm C mammdwhmghav prnduce a y en level nl nulpul cost c lt q allhe same cnsl C wL o m c I Rearranging K vacmm Fnrgiven inpulprices lanherlrnm the wig ed with hercnsts or Changes in inpul prints change Iheslnpenllheisncnslline 0 CW Cw isncnsts K are Nm soc5 lamav a 4mm 7 2m waga pm 9mm w gt w Cost Minimization I Marginal product per dollar spent should be equal for all input MP ag 1 w r MPK r I But this 39s just Cost Minimization K FaultsGL1 mp mu M lmmnon any umqu Optimal Input Substitution A mm mnmly muum a K hy Ennl ylnn e mmhmaunn m Innuls mnmsenlm Wrmlm A a a mst m cquot In nrnuucelhe sm level at mum on me rm will quum an a law Isumsl lIn a the snnemmenew Isumsl lIn mm nls Ihelnwa wane mama the mnal me at Emnal lwcmnsmg 0m Types of Costs I S o un leed costs we Sunk costs Shortrun variable costs we s honrun total costs no CQ Minimum total cost 3 ofproducing alterna 39ve levels ofoutput CQ VCQ FC VCQ Costs that vary with output FC Costs that do not vary with output cQVcrC VcQ 2 as nutput chang kcust Aeustthatrs Deersrun makers shnuld nk eusts tn 3 a FC custsthatdu nut ehange 3 es Sun furever lest a er rt has been para maxumze pm t er muurruze es clt vcm VcQ Average Tntal cust c Avc AFC ATc CQQ Average Vaname cust Avc VCQQ Average Fured cust c FCQ Margmal cust MC ACAQ QHKATCVAVC Qn x AFC QnKFCQn anAVC v CQn erVCQrQn anATC ancQnQn cQn Cubic Cost Function 39C0fa0h02003 I Marginal Cost Memorize mm a 2m 3c02 Calculus dCIdQ a ZhQ 3002 M An Exam ple Total Cost CQ 10 o 02 Variable cost function 310 Q o 07 Variable cost of producing 2 units z m1 6 Fixed cost F 1n Marginal cost function MCIQ 1 om Marginal cost of producing 2 units MCiZ1oZiZ5 LongRun Average Costs MultiProd uct Cost Function CQ1 Q Cost ofjointly producing two outputs I General function form CQQzaQQbQEcQ Economies of Scope 39 Clo 0 CW 02 gt 01102 It is cheaper to produce the two outputs jointly instead of separately I Exam le It is cheaper for TimeWarner to produce Internet connections and Instant Messaging services jointly than separately Cost Com plementarity I The marginal cost of producing good 1 declines as d more of good two is produce AMC1Q102 A02 lt o I Example Cow hides and steaks Quadratic MultiProduct Cost Function 39 C0102lfI aoiozI 01F I 02F Mc1o1 oz a02201 I Economies of scope f gt a010 Co1lo CW 02 f I 01 2 I f I 022 01102 f I aoloz I 01F I 02 l2 r gt a0102 Joint production is cheaper A Numerical Example 39 01021 90 10102 I 01 l2 I 02 l2 I Cost Complementarity I es since a 2 lt 0 MC1Q1 02 402 201 I Economies of Scope Ves since 90 gt 20102 Conclusion To maximize profits minimize costs managers must use inputs such that the value of marginal of each input re ects price the rm must pay to e oy the input The optimal mix orinputs is achieved when the MRTsKL wr Cost runctions arethefoundationforhelping to determine pro tm axiniizing behavior in future chapters agement Economics 5 910 anizatlon of the Firm Overview I Methods of Procuring Inputs I Spot Exchange I Cont acts I Vertical Integration ll Transaction Costs I S e 39 p c Investments Ill Optimal Procurement Input IV PrincipalAgent Problem OwnersManagers I ManagersWorkers Manager s Role Prueureinputs in the least cost manner like point a 39 Provide incentives Inr wurkerstu put lurth ellurt W Acquire Inputs hyth least costly rnethud Methods of Procuring Inputs Spot Exchange hen the buyer and seller ofan input rneet exchange and then gotheir separate ways egal document that creates an extended relationship between a buyer and a seller other suppliers and chooses to produce an input internally Key Features Spot Exchange Specialization avoids contracting costs avoids costs of vertical integration I Possible holdup problemquot Contracting Specialization reduces opportunisrn skimping on specialized investment 39 ironments avoids s opportunisrn avoids contracting costs Lost specialization and mayincrease organizational costs Trans action Costs I Costs of acquiring an input over and above the amount paid to the input supplier I Includes I Search costs I Negotiation c I Other required investments or expenditures I Some transactions are general in nature while others are speci c to a trading relatlonship Investments made to allow b relationshi Types of specialized investments Site speci city Physicalasset Dedicated asse capital Lead to highertransaction costs Costly bargaining Underinvestment Dpportunism and the holdup problem specificity ts two parties to exchange ut has little or no value outside ofthe exchange p Specialized Investments and Contract Length s Specialized Investments and Contract Length 3 MC lt i Shim4 Contact U 11 Li cmm Lenevh Specialized Investments and Contract Length s Optimal Input Procurement Spat Exchange eniul lnlngnl39n Man princ int The PrincipalAgent Problem Occurs when the principal cannot observe the effort ofthe agen Example shareholders principal cannot observe the effort ofthe man t ager agen Example Manager principal cannot observe the effort of workers agents The Problem Principal cannot determine whether a bad outcome was the result of the agent s low effort or due to bad luck ageli s must recognize the existence ofthe lpa erests ofwork rs with that of the F Shareholders must create plans to align the interest ofthe manager with those ofthe shareholders Longer c mutual agent problem and devise plans to alignthe e Irm Solving the Problem Between Owners and Managers I Internal incentives I Incentive contracts I Stock options yearend bonuses I External incentives I Personal reputation I Potential for takeover Solving the Problem Between Managers and Workers I Pro t sharing I Revenue sharing I Time clocks and spot checks Conclusion I The optimal method for acquiring inputs depends on the nature of the transactions costs an specialized nature or me Inputs nelng procured I To overcome the principalagent problem principals must devise plans to align the agents interests with the pri cipals


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