Download Thinking like an Economist

Economics of Information
Technology
2nd session
11.02.2003
Experiencing Microeconomics
Agenda
‘Think like an economist’
1. General Microeconomic concepts
•
Supply demand and cost functions
2. Microeconomics and the information product
•
First copy costs ,MC, Sunk costs, price differentiation
3. Organization of the course
•
Introduction
Group presentation and preparation of the academic
summaries
2
1.1 Supply Demand schedules
Price
D
S
Equilibrium (EQ)
P0
S0
Introduction
Quantity
3
1.1 Supply Demand schedules
Effect of a tax imposition on the demand curve ( i.e. VAT tax)
Price
D
S
P0
PT
EQT
Introduction
QT
Q0
Quantity
4
1.1 Supply Demand
Effect of a tax imposition on the supply curve ( i.e corporate tax)
Price
D
ST
S
EQT
PT
P0
Introduction
QT Q0
Quantity
5
1.2 Price Elasticity of Demand
Price
P1
DSR
•
DLR
Price elasticity is greater in the long
run (LR) than in the short rum (SR)
P0
Introduction
QLR
QSR Q0
Quantity
6
1.2 Price Elasticity of Demand
Price Elasticity  is the % change of a quantity demanded, brought by
1% change in price
Price elasticity = n =Change Q
Q0
:
Change P
P0
If n < 1  demand is inelastic
If n > 1  demand is elastic
Example: n = 0,75 and change P= + 3%  change in demand = 2,25%
Introduction
7
1.2 Price Elasticity of Demand
P
P
Perfectly elastic demand
Q
•
Introduction
Perfectly inelastic
demand
Q
Price elasticity is greater in the long
run (LR) than in the short rum (SR)
8
1.2 Price elasticity of demand
Factors that make demand for a product more sensitive:
1.
Unique product features, product differentiation
2.
High proportion of buyers expenditures
3.
Intermediate products in price sensitive industries such as PC industry
Factors that make demand for a product less sensitive:
1.
Difficult to compare products/services
2.
Low proportion of buyers expenditures
3.
High costs to switch to another product
4.
Products compatibility or product network effects
Introduction
9
1.3 Cost Functions -
Total Costs
Total Costs = FC + VC
Cost
Total Costs (TC)
Variable Costs (VC)
FC
Fixed Costs (FC)
Introduction
QT Q0
Quantity
10
1.3 Cost Functions -
Total Costs
Total Costs = FC + VC
Total Costs (TC)
Cost
Variable Costs (VC)
Fixed Costs (FC)
Introduction
Quantity
11
1.3 Cost Functions -
Average Costs
Average Costs = TC/Q
Cost =C
Average Costs (AC)
Introduction
Quantity
12
1.3 Cost Functions –
Minimum efficient
scale of production (MES)
Average Costs schedules of ‘ old economy firms’
C
C
AC
Economies of scale
Minimum efficient scale
Q’
•
•
•
•
Q
Constant returns to scale
Q’
Q’’
Until Q’ economies of scale are present
Minimum efficient scale at Q’ when scale economies are exhausted
Q’ – Q’’ constant returns to scale
Beyond Q’’ diseconomies of scale
Introduction
AC
Diseconomies of scale
Q
13
1.4 Cost Functions -
Constant returns to scale
Average Costs schedules of ‘ new economy information good firms
C
Diseconomies of scale
AC
Economies of scale
Constant returns to scale
Q
• Constant returns to scale theoretically until infinity
Introduction
14
1.5 Cost Functions –
Marginal Costs
• The cost of expanding output or cost savings contracting
output
• The incremental cost of producing exactly one more unit of
output
• MC (Q) = TC (Q + change Q) – TC (Q)
change Q
• MC (Q) = VC/Q
• Average total costs (ATC) = TC/Q
• Average variable costs (AVC) = VC/Q
Introduction
15
1.5 Cost Functions –
Marginal Costs
C
TC
VC
C
FC
Q
C/Q
In the event of constant returns to scale MC = AC
AC = ATC + AVC
ATC
MC=AC
Introduction
Q
AVC
16
1.5 Cost Functions –
Marginal Costs
TC
TC (Q)
TC ( Q’’ + 1)
TC ( Q’’)
TC ( Q’ + 1)
TC ( Q’)
Q’ Q’+1
Q’’ Q’’+1
MC
Quantity
MC (Q)
MC ( Q’’)
MC ( Q’)
Introduction
Q’
Quantity
Q’’
17
1.5 Cost Functions
Relationship Marginal Costs and Average Cost
1.
When AC is a decreasing function of output  MC < AC
2.
When AC = constant or at MES  MC = AC
3.
When AC is a increasing function of output  MC > AC
C
MC
AV increases
MC > AC
AC
Q
Introduction
18
1.x Price Discrimination
Introduction
19
1.6 Cost Functions
Long-run versus short-run cost functions
•
The period of time in which the firm cannot adjust the size of
its production facilities = short run
•
For each level of output there is an optimal plant size
Example large vs. smaller plant size (see Besanko; figure P.6;
pg. 17)
Optimal plant size produces savings from:
1.
2.
3.
Introduction
Lower costs from adequate plant size by either reduction of
the fixed costs or the utilization of scale economies
More efficient labor allocation, better control over VC
Optimization of the plants organization
20
1.6 Cost Functions
Sunk Costs
•
Sunk costs are not fixed costs ( e.g. railroad locomotives)
•
The opposite of sunk costs are avoidable costs
•
Sunk investments are industry specific assets that
would neither increase value, nor reduce costs when
applied to a different product market. Usually up front
investments
•
Sunk costs are important for the study of industry
strategy, the analysis of rivalry among firms, entry
and exit decisions into markets and decisions to adopt
new technologies
Introduction
21
1.7 Economic Costs
Economic Costs versus Accounting Costs
• Accounting Profit = Sales revenues – Accounting cost
• Economic profit = very close related to the principle
opportunity cost
• Economic profit = Sales Revenue – Economic Cost
• Economic cost = closely aligned with the return on invested
capital (ROI), such as plant & equipment
• Economic profit = Sales Revenue – economic cost – accounting
cost
Introduction
22
1.7 Economic Costs
Economic Profit and Net Present Value
•
Present Value of an annual accounting profit: PV = Cash Flow (C)
(1+i)t
•
Net present value (NPV) = present value of the cash flows generates
minus the cost of the investment
•
NPV = Acc. profit (C) - Cost of the investment
(1+i)t
Introduction
23
2.1 Important Microeconomic concepts
in the ‘Information Economy’
• First copy costs
• Economies of scale
• Sunk costs
• Fixed costs
• Variable costs
• Marginal costs
Introduction
24
2.2 Costs and competition in the
Information Economy
• Sunk costs =>industry specific assets that would neither increase value,
nor reduce costs when applied to a different product market. Usually up front
investments
• First copy costs
of an information good are typically high, and typically
cannot be recovered, and are therefore defined as sunk costs
• Marginal costs (MC) =>
the cost of producing an extra unit of a
certain product
• Reproduction costs
of an information good are often constant and
costs essentially nothing  MC close to zero
• No capacity limits for the reproduction of information goods
Introduction
25
2.3 Costs and competition in the
Information Economy
• Declining production costs are attracting competitors
• Dominant firms have due to the financial leverage
• Marginal costs (MC) =>
the cost of producing an extra unit of a
certain product
• Reproduction costs
of an information good are often constant and
costs essentially nothing  MC close to zero
• No capacity limits for the reproduction of information goods
Introduction
26
3.1 Organization of the course
Group Presentations
Setting:
• The group is performing an consultant firm, while the class is
acting as the top leadership of a respective firm or a
governmental body
• Presentation about 25 min plus 15 min for Q&A
• Hand- in by Monday before the next lecture, latest at 15:00 via
e-mail to: [email protected]
Introduction
27
3.1 Organization of the course
Group Presentations
Structure of the presentations:
•
•
•
Introduction
Industry overview
The firms business model and strategy
•
SWOT analysis of the firm ( competitors, policies and regulations,
technology ect.
•
Elaborate proposal for problem solution, strategy shift or general
improvement of the firms current situation. Show the link to the
theoretical framework of the course
•
List of recommendations
Introduction
28
3.2 Organization of the course
Summary of literature
Summary’s structure
•
•
•
Title and source
Abstract/Conclusions
Key terms and concepts in order of appearance
•
•
•
•
•
Main Questions & assertions
The approach to solve the main questions
Support of assertions
Relationship between terms and concepts
Relation to other articles
Introduction
29