Go Global !Managerial Economics :Production & CostsByStephen OngVisiting Fellow, Birmingham City UniversityVisiting Professor, College ofManagement, Shenzhen UniversityMay 2013
Agenda1. Production2. Cost of production3. The Long Run
Learning ObjectivesTo discuss the production function and itsvarious formsTo provide examples of types of inputs into aproduction function for a manufacturing orservice companyTo understand the law of diminishing returnsTo discuss the cost function and distinguishbetween economic cost and accounting costTo explain how the concept of relevant cost isusedTo understand total, variable, average andfixed costTo distinguish between short-run and long-run costTo provide reasons for the existence ofeconomies of scale
OverviewThe production functionShort-run analysis of averageand marginal productLong-run production functionImportance of productionfunction in managerialdecision making
Production FunctionA productionfunction describesthe relationshipbetween a flow ofinputs and theresulting flow ofoutputs in aproduction processduring a givenperiod of time.Q = f(L, K, M, …)whereQ = quantity of outputL = quantity of labourinputK = quantity of capitalinputM = quantity ofmaterials input
Production function Production function: defines therelationship between inputs and themaximum amount that can be producedwithin a given period of time with a givenlevel of technologyQ=f(X1, X2, ..., Xk)Q = level of outputX1, X2, ..., Xk = inputs used inproduction
Production functionKey assumptionsgiven ‘state of the art’production technologywhatever input or inputcombinations are included in aparticular function, the outputresulting from their utilization isat the maximum level
Production functionFor simplicity we will oftenconsider a production function oftwo inputs:Q=f(X, Y)Q = outputX = labourY = capital
Production function Short-run production function showsthe maximum quantity of output thatcan be produced by a set of inputs,assuming the amount of at least oneof the inputs used remainsunchanged Long-run production function showsthe maximum quantity of output thatcan be produced by a set of inputs,assuming the firm is free to varythe amount of all the inputs beingused
Short-run analysis of Total,Average, and Marginal product Alternative terms in reference to inputs‘inputs’‘factors’‘factors of production’‘resources’ Alternative terms in reference to outputs‘output’‘quantity’ (Q)‘total product’ (TP)‘product’
Fixed and Variable InputsA fixed inputis an inputwhosequantity amanagercannot changeduring a givenperiod of time.A variableinput is aninput whosequantity amanager canchange duringa given periodof time.
Short-Run vs. Long-RunThe short-run is a periodof time during which atleast one input is fixed,while the long-run is aperiod of time duringwhich all inputs arevariable.
Total ProductThe totalquantity ofoutput producedwith givenquantities offixed andvariable inputs.TP or Q = f(L, K ),whereTP or Q = total productor total quantityproducedL = quantity of labourinput (variable)K = quantity of capital(fixed)
Average ProductThe amountof output perunit ofvariableinput.APL = TP÷L or Q÷L,whereAPL = averageproduct of labour
Marginal ProductThe additionaloutputproduced withan additionalunit of variableinput.MPL = ΔTP÷ΔLor ΔQ÷ΔLwhereMPL = marginalproduct of labour
Short-run analysis of Total,Average, and Marginal productMarginal product (MP) = change inoutput (Total Product) resulting froma unit change in a variable inputAverage product (AP) = Total Productper unit of input usedXQMPXXQAPX
Short-run analysis of Total,Average, and Marginal productif MP > AP thenAP is risingif MP < AP thenAP is fallingMP=AP when APis maximized
Short-run analysis of Total,Average, and Marginal productLaw of diminishing returns:as additional units of a variable inputare combined with a fixed input, aftersome point the additional output (i.e.,marginal product) starts to diminishnothing says when diminishingreturns will start to take effectall inputs added to theproduction process have thesame productivity
Law of Diminishing MarginalReturnsThe phenomenon illustrated bythat region of the marginalproduct curve where the curveis positive, but decreasing, sothat total product is increasingat a decreasing rate.
Do increases in health care expendituresreflect increases in output or do theyreflect inefficiencies in the productionprocess? The United States is relativelywealthy, and it is natural for consumerpreferences to shift toward more healthcare as incomes grow. However, it maybe that the production of health care inthe United States is inefficient.A PRODUCTION FUNCTION FOR HEALTH CAREA PRODUCTION FUNCTIONFOR HEALTH CAREAdditional expenditures on healthcare (inputs) increase life expectancy(output) along the productionfrontier. Points A, B, and C representpoints at which inputs are efficientlyutilized, although there arediminishing returns when movingfrom B to C. Point D is a point of inputinefficiency.
MALTHUS AND THE FOOD CRISISTABLE 2INDEX OF WORLDFOOD PRODUCTIONPER CAPITAYEAR INDEX1948-521001961 1151965 1191970 1241975 1251980 1271985 1341990 1351995 1352000 1442005 1512009 155The law of diminishing marginalreturns was central to the thinking ofpolitical economist Thomas Malthus(1766–1834). Malthus predicted thatas both the marginal and averageproductivity of labor fell and therewere more mouths to feed, masshunger and starvation would result.Malthus was wrong (although he wasright about the diminishing marginalreturns to labour).Over the past century,technologicalimprovements have dramaticallyaltered food production in mostcountries (including developingcountries, such as India). As a result,the average product of labour and totalfood output have increased.Hunger remains a severe problem insome areas, in part because of the lowproductivity of labour there.
Cereal yields have increased. The average worldprice of food increased temporarily in the early1970s but has declined since.MALTHUS AND THE FOOD CRISISCEREAL YIELDS AND THE WORLD PRICE OF FOOD
Short-run analysis of Total,Average, and Marginal productThe Three Stages of Production inthe short run:Stage I: from zero units of thevariable input to where AP ismaximized (where MP=AP)Stage II: from the maximum APto where MP=0Stage III: from where MP=0 on
Short-run analysis of Total,Average, and Marginal productIn the short run, rational firms should beoperating only in Stage II Q: Why not Stage III? firm uses morevariable inputs to produce less output Q: Why not Stage I? underutilizingfixed capacity, so can increase output perunit by increasing the amount of the variableinput
Short-run analysis of Total,Average, and Marginal productWhat level of input usage within StageII is best for the firm? answer depends upon:• how many units of output the firm can• sell the price of the product• the monetary costs of employing thevariable input
Short-run analysis of Total,Average, and Marginal product Total revenue product (TRP) = marketvalue of the firm’s output, computedby multiplying the total product bythe market priceTRP = Q x P
Short-run analysis of Total,Average, and Marginal productMarginal revenue product (MRP) =change in the firm’s TRP resulting from aunit change in the number of inputs usedMRP = MP x P =XTRP
Short-run analysis of Total,Average, and Marginal product Total labour cost (TLC) = total cost of usingthe variable input labour, computed bymultiplying the wage rate by the number ofvariable inputs employedTLC = w x X Marginal labour cost (MLC) = change in totallabour cost resulting from a unit change inthe number of variable inputs usedMLC = w
Short-run analysis of Total,Average, and Marginal productSummary of relationship betweendemand for output and demand for asingle input:A profit-maximizing firm operating inperfectly competitive output and inputmarkets will be using the optimal amount ofan input at the point at which the monetaryvalue of the input’s marginal product isequal to the additional cost of using thatinput MRP = MLC
Short-run analysis of Total,Average, and Marginal productMultiple variable inputsConsider the relationship betweenthe ratio of the marginal product ofone input and its cost to the ratio ofthe marginal product of the otherinput(s) and their costkkwMPwMPwMP2211
Will the standard of living in the United States, Europe, andJapan continue to improve, or will these economies barely keepfuture generations from being worse off than they are today?Because the real incomes of consumers in these countriesincrease only as fast as productivity does, the answer dependson the labour productivity of workers.LABOUR PRODUCTIVITY AND THE STANDARD OF LIVINGTABLE 3LABOUR PRODUCTIVITY IN DEVELOPEDCOUNTRIESUNITEDSTATES JAPAN FRANCE GERMANYUNITEDKINGDOMGDP PER HOUR WORKED (IN 2009 USDOLLARS)$56.90 $38.20 $54.70 $53.10 $45.80Years Annual Rate of Growth of Labor Productivity (%)1960-1973 2.29 7.86 4.70 3.98 2.841974-1982 0.22 2.29 1.73 2.28 1.531983-1991 1.54 2.64 1.50 2.07 1.571992-2000 1.94 1.08 1.40 1.64 2.222001-2009 1.90 1.50 0.90 0.80 1.30
Long-run production function In the long run, a firm has enough time tochange the amount of all its inputs The long run production process isdescribed by the concept of returns to scaleReturns to scale = the resultingincrease in total output as allinputs increase
Long-run production functionIf all inputs into the production processare doubled, three things can happen:output can more than double ‘increasing returns to scale’ (IRTS)output can exactly double ‘constant returns to scale’ (CRTS)output can less than double ‘decreasing returns to scale’ (DRTS)
Long-run production functionOne way to measure returns to scaleis to use a coefficient of outputelasticity:if EQ > 1 then IRTSif EQ = 1 then CRTSif EQ < 1 then DRTSinputsallinchangePercentageQinchangePercentageQE
Long-run production functionReturns to scale can also bedescribed using the followingequationhQ = f(kX, kY)if h > k then IRTSif h = k then CRTSif h < k then DRTS
Long-run production functionGraphically, the returns to scaleconcept can be illustrated usingthe following graphsQX,YIRTSQX,YCRTSQX,YDRTS
Food grown on large farms in the UnitedStates is usually produced with acapital-intensive technology.However, food can also be producedusing very little capital (a hoe) and a lotof labour (several people with thepatience and stamina to work the soil).Most farms in the United States andCanada, where labor is relativelyexpensive, operate in the range ofproduction in which the MRTS isrelatively high (with a high capital-to-labour ratio), whereas farms indeveloping countries, in which labour ischeap, operate with a lower MRTS (anda lower capital-to-labour ratio).A PRODUCTION FUNCTION FOR WHEAT
A PRODUCTION FUNCTION FOR WHEATISOQUANT DESCRIBING THEPRODUCTION OF WHEATA wheat output of 13,800bushels per year can beproduced with differentcombinations of labour andcapital.The more capital-intensiveproduction process is shownas point A,the more labour- intensiveprocess as point B.The marginal rate of technicalsubstitution between A and Bis 10/260 = 0.04.
Estimation of productionfunctions Examples of production functions short run: one fixed factor, one variable factorQ = f(L)K cubic: increasing marginal returns followed bydecreasing marginal returnsQ = a + bL + cL2 – dL3 quadratic: diminishing marginal returns but noStage IQ = a + bL - cL2
Estimation of productionfunctionsExamples of production functionspower function: exponential for one inputQ = aLbif b > 1, MP increasingif b = 1, MP constantif b < 1, MP decreasingAdvantage: can be transformed into a linear(regression) equation when expressed in logterms
Estimation of production functions Examples of production functionsCobb-Douglas function:exponential for two inputsQ = aLbKcif b + c > 1, IRTSif b + c = 1, CRTSif b + c < 1, DRTS
Estimation of production functionsStatistical estimation of productionfunctionsinputs should be measured as ‘flow’rather than ‘stock’ variables, which isnot always possibleusually, the most important input islabourmost difficult input variable is capitalmust choose between time series andcross-sectional analysis
Estimation of production functionsAggregate production functions: wholeindustries or an economy gathering data for aggregatefunctions can be difficult: for an economy … GDP could beused for an industry … data fromCensus of Manufactures orproduction index from FederalReserve Board for labour … data from Bureauof Labour Statistics
Importance of productionfunctions in managerialdecision makingCapacity planning: planning the amountof fixed inputs that will be used alongwith the variable inputsGood capacity planning requires:accurate forecasts of demandeffective communication between theproduction and marketing functions
Importance of productionfunctions in managerialdecision makingExample: cell phones Asian consumers want new phoneevery 6 months demand for 3G products Nokia, Samsung, SonyEricssonmust be speedy and flexible
Importance of productionfunctions in managerialdecision makingExample: Zara Spanish fashion retailer factories located close to stores quick response time of 2-4 weeks
Importance of productionfunctions in managerialdecision makingApplication: call centers service activity production function isQ = f(X,Y)where Q = number of callsX = variable inputsY = fixed input
Importance of productionfunctions in managerial decisionmakingApplication: China’sworkers Is Chinarunning out ofworkers? Effect ofindustrial boom eg bicyclefactory inGuangdongProvince
OverviewDefinition and use of costRelating production and costShort run and long run costEconomies of scope and scaleSupply chain managementWays companies have cutcosts to remain competitive
Cost FunctionA mathematical orgraphic expression thatshows the relationshipbetween the cost ofproduction and the levelof output, all otherfactors held constant.
Opportunity CostThe economic measure ofcost that reflects the use ofresources in oneactivity, such as a productionprocess by one firm, in termsof the opportunities forgonein undertaking the next bestalternative activity.
Explicit and Implicit CostsA cost is explicit ifit is reflected in apayment to anotherindividual, such asa wage paid to aworker, that isrecorded in a firm’sbook keeping oraccounting system.A cost thatrepresents thevalue of using aresource that is notexplicitly paid outand is often difficultto measure becauseit is typically notrecorded in a firm’saccounting system.
ProfitThe differencebetween the totalrevenue a firm receivesfrom the sale of itsoutput and the totalcost of producing thatoutput.
Accounting vs.Economic Profit Accounting profit isthe differencebetween totalrevenue and totalcost where costincludes only theexplicit costs ofproduction. Economic profit isthe differencebetween totalrevenue and totalcost where costincludes both theexplicit and anyimplicit costs ofproduction.
Short Run Cost FunctionA cost function for ashort-run productionprocess in which there isat least one fixed input ofproduction.
Fixed vs. Variable CostsFixed cost is thetotal cost of usingthe fixedinput, whichremains constantregardless of theamount of outputproduced.Variable costis the totalcost of usingthe variableinput, whichincreases asmore output isproduced.
Short Run CostsCOST FUNCTION DEFINITIONTotal fixed cost TFC = (PK) x (K)Total variable cost TVC = (PL) x (L)Total cost TC = TFC + TVCAverage fixed cost AFC = TFC ÷ QAverage variablecostAVC = TVC ÷ QAverage total cost ATC = TC ÷ Q = AFC +AVCMarginal cost MC = ΔTC ÷ ΔQ = ΔTVC÷ ΔQ
Relationship Between ShortRun Production and CostACMCQ1 Q2
Importance of costin managerial decisionsWays to contain or cut costs popularduring the past decade -most common: reduce number ofpeople on the payrolloutsourcing components of thebusinessmerge, consolidate, then reduceheadcount
Definition and use ofcost in economic analysis Relevant cost: a cost that is affected by amanagement decision Historical cost: cost incurred at the time ofprocurement Opportunity cost: amount or subjective valuethat is forgone in choosing one activity overthe next best alternative Incremental cost: varies with the range ofoptions available in the decision Sunk cost: does not vary in accordance withdecision alternatives
Relationship betweenproduction and costCost function is simply theproduction function expressedin monetary rather thanphysical unitsWe assume the firm is a ‘pricetaker’ in the input market
Relationship betweenproduction and cost Total variable cost (TVC) = the costassociated with the variable input,found by multiplying the number ofunits by the unit price Marginal cost (MC) = the rate ofchange in total variable costThe law of diminishing returns implies that MCwill eventually increaseMPWQTVCMC
Relationship betweenproduction and costPlotting TP andTVC illustratesthat they aremirror images ofeach otherWhen TPincreases at anincreasing rate,TVC increases ata decreasing rate
Short-run cost functionFor simplicity use the followingassumptions: the firm employs two inputs, labour and capital the firm operates in a short-run production periodwhere labour is variable, capital is fixed the firm produces a single product the firm employs a fixed level of technology the firm operates at every level of output in themost efficient way the firm operates in perfectly competitive inputmarkets and must pay for its inputs at a givenmarket rate (it is a ‘price taker’) the short-run production function is affected by thelaw of diminishing returns
Short-run cost functionStandard variables in the short-run cost function:Quantity (Q) is the amount of outputthat a firm can produce in the shortrunTotal fixed cost (TFC) is the total costof using the fixed input, capital (K)
Short-run cost functionStandard variables in the short-runcost function:Total variable cost (TVC) is thetotal cost of using the variableinput, labour (L)Total cost (TC) is the total cost ofusing all the firm’s inputs,TC = TFC + TVC
Short-run cost functionStandard variables in the short-runcost function:Average fixed cost (AFC) is theaverage per-unit cost of using thefixed input KAFC = TFC/QAverage variable cost (AVC) is theaverage per-unit cost of using thevariable input LAVC = TVC/Q
Short-run cost functionStandard variables in the short-runcost function:Average total cost (AC) is the averageper-unit cost of all the firm’s inputsAC = AFC + AVC = TC/QMarginal cost (MC) is the change in afirm’s total cost (or total variablecost) resulting from a unit change inoutputMC = DTC/DQ = DTVC/DQ
Short-run cost functionGraphical example of the cost variables
Short-run cost functionImportant observationsAFC declines steadilywhen MC = AVC, AVC is at aminimumwhen MC < AVC, AVC is fallingwhen MC > AVC, AVC is risingThe same three rules apply foraverage cost (AC) as for AVC
Short-run cost functionA reduction in the firm’s fixed costwould cause the average cost line toshift downwardA reduction in the firm’s variable costwould cause all three cost lines (AC,AVC, MC) to shift
Short-run cost functionAlternative specifications of theTotal Cost function (relatingtotal cost and output)cubic relationshipas output increases, totalcost first increases at adecreasing rate, thenincreases at an increasingrate
Short-run cost functionAlternative specifications of theTotal Cost function (relating totalcost and output)quadratic relationshipas output increases, total costincreases at an increasing ratelinear relationshipas output increases, total costincreases at a constant rate
Innovations have reduced costs and greatly increased carpetproduction. Innovation along with competition have workedtogether to reduce real carpet prices.Carpet production is capital intensive. Over time, the majorcarpet manufacturers have increased the scale of theiroperations by putting larger and more efficient tufting machinesinto larger plants. At the same time, the use of labour in theseplants has also increased significantly. The result?Proportional increases in inputs have resulted in a more thanproportional increase in output for these larger plants.RETURNS TO SCALE IN THE CARPET INDUSTRYTABLE 5 THE U.S. CARPET INDUSTRYCARPET SALES, 2005 (MILLIONS OF DOLLARS PER YEAR)1. Shaw 43462. Mohawk 37793. Beaulieu 11154. Interface 4215. Royalty 298
It is important to understand the characteristics of production costsand to be able to identify which costs are fixed, which are variable,and which are sunk.Good examples include the personal computer industry (where mostcosts are variable), the computer software industry (where most costsare sunk), and the pizzeria business (where most costs are fixed).Because computers are very similar, competition is intense, andprofitability depends on the ability to keep costs down. Mostimportant are the cost of components and labour.A software firm will spend a large amount of money to develop a newapplication. The company can recoup its investment by selling asmany copies of the program as possible.For the pizzeria, sunk costs are fairly low because equipment can beresold if the pizzeria goes out of business. Variable costs are low—mainly the ingredients for pizza and perhaps wages for a workers toproduce and deliver pizzas.SUNK, FIXED, AND VARIABL E COSTS:COMPUTERS, SOFTWARE, AND PIZZAS
The production of aluminum begins with the mining of bauxite. The process used toseparate the oxygen atoms from aluminum oxide molecules, called smelting, is themost costly step in producing aluminum. The expenditure on a smeltingplant, although substantial, is a sunk cost and can be ignored. Fixed costs arerelatively small and can also be ignored.THE SHORT-RUN COST OF ALUMINUM SMELTINGTABLE 7 PRODUCTION COSTS FOR ALUMINUM SMELTING($/TON) (BASED ON AN OUTPUT OF 600TONS/DAY)PER-TON COSTS THAT ARECONSTANT FOR ALL OUTPUT LEVELSOUTPUT 600TONS/DAYOUTPUT 600TONS/DAYElectricity $316 $316Alumina 369 369Other raw materials 125 125Plant power and fuel 10 10Subtotal $820 $820PER-TON COSTS THAT INCREASE WHENOUTPUT EXCEENDS 600 TONS/DAYLabor $150 $225Maintenance 120 180Freight 50 75Subtotal $320 $480Total per-ton production costs $1140 $1300
Long Run Production FunctionA productionfunction showingthe relationshipbetween a flow ofinputs and theresulting flow ofoutput, where allinputs arevariable.Q = f(L, K)whereQ = quantity of outputL = quantity of labourinput (variable)K = quantity of capitalinput (variable)
Input SubstitutionA manager’s choice of inputswill be influenced by:The technology of theproduction processThe prices of the inputs ofproductionThe set of incentives facing thegiven producer
Technology of the ProductionProcessCapital-intensivemethod ofproduction is aprocess that useslarge amounts ofcapital equipmentrelative to theother inputs toproduce the firm’soutput.Labour-intensivemethod ofproduction is aprocess that useslarge amounts oflabour relative tothe other inputsto produce thefirm’s output.
The Incentives Facing a GivenProducerThe Role ofCompetitiveEnvironmentsLabour IssuesNonprofitOrganizationsPolitical andLegislativeInfluences
Long Run Average CostFunctionThis is defined as theminimum average or unitcost of producing any level ofoutput when all inputs arevariable.
Long-run cost function In the long run, all inputs to a firm’sproduction function may be changed because there are no fixed inputs, thereare no fixed costs the firm’s long run marginal costpertains to returns to scale at first increasing returns to scale, thenas firms mature they achieve constantreturns, then ultimately decreasing returnsto scale
Long Run Average CostCurveQ$SRAC1SRAC2SRAC3SRAC4LRAC
Long-run cost functionIn long run, the firm canchoose any level ofcapacityOnce it commits to alevel of capacity, at leastone of the inputs mustbe fixed. This thenbecomes a short-runproblemThe LRAC curve is anenvelope of SRACcurves, and outlines thelowest per-unit costs thefirm will incur over arange of output
Long-run cost functionWhen a firm experiencesincreasing returns to scale:a proportional increase in all inputsincreases output by a greaterproportionas output increases by somepercentage, total cost of productionincreases by some lesser percentage
Long-run cost functionEconomies of scale: situationwhere a firm’s long-run averagecost (LRAC) declines as outputincreasesDiseconomies of scale: situationwhere a firm’s LRAC increases asoutput increasesIn general, the LRAC curve is u-shaped.
Economies and Diseconomies ofScaleEconomies ofscale exist when thefirm can achievelower unit costs ofproduction byadopting a largerscale of production,represented by thedownward slopingportion of along-runaverage cost curve.Diseconomies ofscale exist when thefirm incurs higherunit costs ofproduction byadopting a largerscale of production,represented by theupward slopingportion of a long-runaverage cost curve.
Economies and Diseconomies ofScale - GraphicalSATC1SATC2SATC3LRAC$QQ1Economies of scaleDeclining LRACDiseconomies of scaleIncreasing LRAC
Long-run cost functionReasons for long-run economiesspecialization of labour and capitalprices of inputs may fall withvolume discounts in firm’spurchasinguse of capital equipment with betterprice-performance ratioslarger firms may be able to raisefunds in capital markets at a lowercostlarger firms may be able to spreadout promotional costs
Factors Creating Economies of ScaleSpecialization and division of labourTechnological factorsThe use of automation devicesQuantity discountsThe spreading of advertising costsFinancial factors
Long-run cost functionReasons for diseconomies of scalescale of production becomes so largethat it affects the total market demandfor inputs, so input prices risetransportation costs tend to rise asproduction grows, due to handlingexpenses, insurance, security, andinventory costs
Factors Creating Diseconomiesof ScaleThe inefficiencies of managinglarge-scale operations.The increased transportationcosts that result fromconcentrating production in asmall number of very largeplants.
Learning By DoingThe drop in unit costs astotal cumulative productionincreases because workersbecome more efficient asthey repeat their assignedtasks.
Learning curveLearning curve: line showingthe relationship between labourcost and additional units ofoutput• downward slope indicatesadditional cost per unit declinesas the level of output increasesbecause workers improve withpractice
Learning curve Learning curve:• measured in terms of percentage decrease inadditional labour cost as output doublesYx = KxnYx = units of factor or cost toproduce the xth unitK = factor units or cost to producethe Kth (usually first) unitx = product unit (the xth unit)n = log S/log 2S = slope parameter
Methods for Determining MESSurveys of expert opinion(engineering estimates)Statistical cost estimationThe survivor approach
Surveying Expert OpinionSurveying expert opinion is a time-consuming process that relies onthe judgments of those individualsclosely connected with differentindustries.Reporting biases may obviouslyoccur with this approach.
Statistical EstimationResearchers attempt to estimate therelationship between unit costs andoutput levels of firms of varying sizeswhile holding constant all otherfactors influencing cost in addition tosize.This is usually done with multipleregression analysis.
Survivor ApproachThe size distribution of firms isexamined to determine the scale ofoperation at which most firms in theindustry are concentrated.The underlying assumption is thatthis scale of operation is mostefficient and has the lowest costsbecause this is where most firmshave survived.
Economies of scopeEconomies of scope: reductionof a firm’s unit cost byproducing two or more goods orservices jointly rather thanseparatelyClosely related to economies ofscale
Supply chain management Supply chain management (SCM): efforts bya firm to improve efficiencies through eachlink of a firm’s supply chain from supplier tocustomer• transaction costs are incurred by usingresources outside the firm• coordination costs arise because ofuncertainty and complexity of tasks• information costs arise to properlycoordinate activities between the firm andits suppliers
Supply chain managementWays to develop better supplierrelationshipsstrategic alliance: firm and outsidesupplier join together in some sharingof resourcescompetitive tension: firm uses two ormore suppliers, thereby helping thefirm keep its purchase prices undercontrol
Ways companies cutcosts to remain competitive the strategic use of cost reduction in cost of materials using information technology to reduce costs reduction of process costs relocation to lower-wage countries orregions mergers, consolidation, and subsequentdownsizing layoffs and plant closings
Global applicationExample: manufacturingchemicals in China labour content relatively low high use of equipment andraw materials non cost reasons foroutsourcing
Conclusion“The British supermarkets are leadinga race to the bottom. Jobs are beinglost and producers are having to payless attention to social andenvironmental agreements…”Alistair Smith, Banana Link
Casestudy : FORD and the WorldAutomobile Industry (2009)1. Read and prepare theCasestudy on FORDfor discussion andpresentation nextweek.2. Identify and evaluatethe challenges facingFORD’s globalbusiness byconducting ExternalEnvironment analysis(PESTEL);andIndustry (5+1 Forces)analysis.
Core Reading• Keat, Paul G. and Young, Philip KY (2009)Managerial Economics, 6th edition, Pearson• Samuelson, William F. and Marks, StephenG.(2010) Managerial Economics, 6th edition, JohnWiley• Pindyck, Robert S. and Rubinfeld, Daniel L.(2013)Microeconomics, 8th edition, Pearson• Samuelson, P.A. and Nordhaus, W. D.(2010)“Economics” Irwin/McGraw-Hill, 19thEdition• Porter, Michael E. (2004)“Competitive Strategy –Techniques for Analyzing Industries and Competitors”Free Press