Supply

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Supply

• Dr. Yi LU
• January, 2008

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Introductory Story DRAM production
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Introductory Story DRAM production

• DRAM (dynamic random access memory) chips are an
  essential component of personal computers, mobile
  telephones, and other electronic devices.
• Technology evolved quickly, from 4 megabit to now
  4 gigabit DRAM.
• Dominance in manufacturing has shifted from US to
  Japan, and to South Korea.
• However, the massive increase of supply from
  South Korean and the Asian financial crisis
  pulled down the DRAM prices.

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Introductory Story China Mobile and China Unicom

• This caused many firms to reorganize or exit the
  markets.
• Samsung (29.1) Micro (21.2), Infineon Tech.
  (18.5), Hynix (15.3)
• Elipida, and two Taiwanese (Nanya and Winbond)
  lt5

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Introductory Story China Mobile and China Unicom

• Questions
• Why did Nanya and Winbond continue in production?
• How would Nanya-Infineon 300mm joint venture
  affect world supply?

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Sketch

• cost analysis
• short/long run
• supply
• seller surplus

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Cost Analysis adjustment time

• short run time horizon within which seller
  cannot adjust at least one input
• long run time horizon long enough for seller to
  adjust all inputs

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Cost Analysis fixed and variable costs

• Analyze total cost into two categories
• fixed cost does not vary with production scale
• variable cost does vary
• Accounting records do not directly provide costs
  in terms of fixed/variable
• Variable/fixed cost analysis two steps
• use accounting records to estimate costs of
  alternative production rates
• further analyze into variable/fixed

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Cost Analysis fixed and variable costs
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Cost Analysis fixed and variable costs
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Cost analysis Common misconception

• capital expenditure fixed cost
• labor variable cost
• European countries and India -- strong worker
  protection laws, hence difficult to lay off
  workers for economic reasons ? labor is fixed
  cost for a very long horizon
• Japan -- traditionally, large corporations
  guaranteed life-time employment

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Cost analysis
total cost
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Cost (Thousand )
variable cost
6
4
2
fixed cost
0
2
4
6
8
Production rate (Thousand dozens a week)
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Cost analysis Marginal/average costs

• marginal product increase in output arising
  from an additional unit of the input
• diminishing marginal product -- with higher
  production rate,
• average variable cost increases
• average total cost increases
• Hence, average variable, average (total), and
  marginal cost curves are U-shaped.

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Cost analysis Marginal/average costs
Cost (Cents per dozen)
marginal cost
average cost
average variable cost
2
4
6
8
Production rate (Thousand dozens a week)
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Short-run

• Objective profit maximization
• Price-taken so small relative to the market as
  its production cannot affect the price in the
  market.

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Short-run
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Short-run
total cost
variable cost
total revenue
4.097
Cost/revenue (Thousand )
2.8
0
1
4
9
Production rate (Thousand dozens a week)
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Short-run
Cost (Cents per dozen)
marginal cost
average cost
marg revenue price
average variable cost
2
4
6
8
Production rate (Thousand dozens a week)
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Short-run

• Profit-maximizing (loss-minimizing) scale
• where marginal revenue equals marginal cost, or
  equivalently,
• where price equals marginal cost

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Short-run

• Sunk cost committed and cannot be avoided
• should be ignored in forward-looking decision
• For competitive market analysis, assume fixed
  cost sunk cost
• Hence, business should continue in operation
  provided that loss no greater than fixed cost

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Short-run

• Business should continue in operation provided
  that
• revenue covers variable cost, or equivalently,
• provided that price covers average variable cost

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Short-run DRAM industry, 2003-04

• Why did Nanya and Winbond continue in production?

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Short-run DRAM industry, 2003-04

• In January 2002, the price of a 128-Megabit DRAM
  was US3.40, fell to US1.98 in June and
  rebounded back to US3.54 in January 2004.
• DRAM manufacturing is a capital-intensive
  business, and the average variable cost of
  production is very low.

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Long run
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Long run

• Decision
• whether to enter/exit
• price gt average cost
• scale of operation
• where marginal cost price

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Long run
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Long-run Fujitsu

• In early 1998, Fujitsu shut down the DRAM factory
  in Durham, England but continued the factory in
  Gresham, Oregon.
• Durham 590 million investment plus 1 billion
  further investment to produce 64-megabit while
  the industry is working on 256-megabit DRAM.
• Gresham already able to produce 64-megabit.
• Thus the decision in Gresham is short-run while
  in Durham is long-run.

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Supply Individual

• Graph of quantity that seller will supply at
  every possible price
• follows marginal cost curve above minimum
  average variable cost
• slopes upward increasing marginal cost of
  production (or decreasing marginal return to
  inputs)

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Supply Two interpretations

• For every possible price, it shows the
  production/ delivery rate
• For each unit of item, it shows the minimum price
  that the seller is willing to accept

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Supply Short-run

• Graph of quantity that all sellers will supply at
  every possible price
• horizontal sum of individual supply curves
• lowest cost seller defines starting point
• gradually, blends in higher-cost sellers
• slopes upward

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Supply

• Change in
• price -- movement along curve
• input prices or other factors -- shift curve

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Supply Cabbies in Beijing, China

• About 90,000 taxi drivers and 66,000 licensed
  taxis in Beijing
• Owned by 227 taxi companies and individual
• Total revenue a year is 6.15 billion Yuan
• But most goes to taxi companies
• Drivers income per month is less than 2,000 Yuan
• Beijing announced to raise taxi fares by 25
  percent in May, 2006.
• 1.6 Yuan per kilometer to 2 Yuan.

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Supply Cabbies in Beijing, China

• Government concerns
• Prompted by the surge in oil prices
• 80 of the taxi users in the city earn a monthly
  income of more than 4,500 Yuan.
• Results
• Huge drop in customers
• Taxi drivers staged a major walkout in a protest
  in July 2006.
• Working 12 hours a day and sometimes seven days a
  week but monthly income is just around 2,000.

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Supply Long-run

• long run -- freedom of entry and exit
• if a business earns profits
• attracts new entrants
• increases market supply
• reduces market price
• if business makes loss, will exit

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Supply Investors pour money intro risky energy
plays

• Barry Kostiner, trader for electricity and
  natural gas, set up a oil-and-gas company with no
  experience and asset behind.
• He carried out an IPO in NY and raised 115
  million in 2006.
• There were a lot of such kind of stories.
• Carlyle Group raised 4.5 billion at six weeks
  old.
• All these because of the gravity-defying rise of
  oil prices and the boom in investment pools that
  cater to the deep-pocketed institutions and the
  wealthy.

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Supply DRAM industry, 2003-04

• How would Nanya-Infineon 300mm joint venture
  affect world supply?
• 300mm technology is lowest variable cost
• Nanya-Infineon joint venture would increase
  lowest part of short and long-run supply curves

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Supply Short/long-run

• Long-run supply
• gentler than short-run supply
• price increase will attract new sellers so
  expansion in two ways
• along marginal cost of existing sellers
• addition of new sellers

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Supply Short/long-run
short-run market supply
80
long-run market supply
70
65
Price (cents per dozen)
0
20
15
13
12
7.4
Production rate (thousand dozens a week)
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Supply Price elasticity

• Definition percentage by which quantity
  supplied will change if the price of the item
  rises by 1
• usually, positive number
• supply more elastic with time
• Intuitive factors in elasticity of supply of
  product
• capacity utilization
• adjustment time

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Supply Price elasticity
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Supply Labor

• marginal cost of labor -- benefit from
  alternative use of time
• with higher wage rate
• some people work longer and harder
• however, some might work less

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Supply why is overtime rate so high?

• Typical employment contract is bulk order of 40
  hours a week
• extracts workers seller surplus
• regular wage rate reflects the workers average
  cost of labor for 40 hours a week.
• Overtime rate is also bulk order -- must cover
  workers marginal cost for hours gt 40

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In China, what is the wage-elasticity of the
labor supply?
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Supply will tax cut generate growth?

• In Jan 2001, Bush Administration proposed 1.6
  trillion tax cut for 10 years
• reduce 39.6 and 36 income tax brackets to 33
• reduce 31 and 28 brackets to 25
• divide 15 bracket into 15 and 10
• How will people respond to higher (after-tax)
  wages?

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Seller surplus

• Individual seller surplus revenue a seller gets
  from a product minus production cost
• Market seller surplus sum of individual seller
  surpluses

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Seller surplus Individual
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Seller surplus Lihir Gold IPO, 1995

• Projected profit in 1999
• 52m if gold price 400 per ounce
• 76m if gold price 450 per ounce
• Why would a 12.5 increase in gold price raise
  profit by 46?