Download Market Outcomes - College of Business and Economics

Producer & Consumer Decisions
Unfinished Business
Executive MBA 512
Session #11 November 17, 2016
Brian Greber
1
2
Costs and rational decisions
•Average fixed cost
•Understand effect of scale on “leveraging” costs at time of making an
investment – once made, its sunk!
•Average variable cost
•Key controllable cost on a day-to-day basis;
• key to shut down economics
•Produce as long as P > AVC
•Average total cost
•Standard for “cost accounting”; approximation of profit
•A result, not a decision criteria!
•Marginal cost
•Key to determining profit maximizing production/sales levels
•Competitive firm Produce to where P=MC
3
“Rationale Product Pricing”
MC
Shift #
1
2
3
# Trailers
Cost / shift/
Monthly
made/Shift/
month
Production
month
$32,000
$35,000
$36,000
200
175
160
200
375
535
FC
10000
10000
10000
VC
32000
67000
103000
TC
42000
77000
113000
AFC
AVC
50
27
19
ATC
160
179
193
9 People
Shift AC
210
205
211
0 Person
6 People – 10%-100% higher
160
200
225
4
Law of Supply
•Other things equal, as price rises the quantity
supplied rises
•Corollary: as quantities produced increase,
the price required in the market must rise.
Why might this be for individual firms?
For the Market as a whole?
Individual Supply
Supply curve “maps” the price that it would take to entice the producer to
supply one more unit; it is “minimum acceptable price”
P
6
S1
P
$5
Qs
60
4
50
3
35
2
20
1
5
Price (per bushel)
5
4
3
2
1
0
10
20
30
40
50
60
Q
70
Quantity Supplied (bushels per week)
5-5
5
Individual Supply
P
6
S3
S1
P
$5
Qs
60
4
50
3
35
2
20
1
5
Price (per bushel)
5
S2
4
3
2
1
0
10
20
30
40
50
60
Q
70
Quantity Supplied (bushels per week)
6
Theoretic Construct
2 Supplier World
Supplier 1
“Market”
Supplier 2
P
P
25
P
S2
20
S1
S
=
5
10 15
+
10
20
30
Q
10
20
30
Q
10
20
30
Q
8
A Supply/Cost Curve Example
•Use an engineering build up, treating each increment of supply available in the market as a “marginal supply”
•This may be turning a plant on or off, opening /closing a new supply reserve, etc.
•Examples from the web:
http://www.mckinseyquarterly.com/Strategy/Strategic_Thinking/Enduring_ideas_The_industry_cost_curve_2343
http://www.minecost.com/curves.htm
Firm
1
Firm's Annual
Fixed Costs
50,000
Plant
A
Plant's Annual
Fixed Costs
27,000
2
125,000
A
20,000
B
30,000
C
10,000
A
15,000
B
12,000
C
20,000
A
12,000
B
12,000
3
4
175,000
200,000
Shift #
a
b
c
a
b
c
a
b
c
a
b
c
a
b
c
a
b
c
a
b
c
a
b
c
a
b
c
Output per
Shift
300
250
210
550
450
350
500
450
400
350
350
350
650
500
350
600
450
400
450
350
250
750
550
450
650
550
500
Cost per Production Cost Per Unit
Shift
Increment Per Shift
14,000
1.A.a
46.67
14,500
1.A.b
58.00
15,000
1.A.c
71.43
19,000
2.A.a
34.55
21,000
2.A.b
46.67
23,000
2.A.c
65.71
17,000
2.B.a
34.00
18,000
2.B.b
40.00
19,000
2.B.c
47.50
14,000
2.C.a
40.00
14,000
2.C.b
40.00
14,000
2.C.c
40.00
18,000
3.A.a
27.69
20,000
3.A.b
40.00
22,000
3.A.c
62.86
16,500
3.B.a
27.50
17,500
3.B.b
38.89
19,000
3.B.c
47.50
17,000
3.C.a
37.78
18,000
3.C.b
51.43
18,000
3.C.c
72.00
29,000
4.A.a
38.67
30,000
4.A.b
54.55
31,000
4.A.c
68.89
24,000
4.B.a
36.92
26,000
4.B.b
47.27
29,000
4.B.c
58.00
9
A Supply/Cost Curve Example
Output per
Shift
600
650
500
550
650
450
750
450
450
350
350
350
500
300
450
550
400
400
350
550
250
500
350
350
450
210
250
Cost per Production Cost Per Unit
Increment Per Shift
Shift
27.50
3.B.a
16,500
27.69
3.A.a
18,000
34.00
2.B.a
17,000
34.55
2.A.a
19,000
36.92
4.B.a
24,000
37.78
3.C.a
17,000
38.67
4.A.a
29,000
38.89
3.B.b
17,500
40.00
2.B.b
18,000
40.00
2.C.a
14,000
40.00
2.C.b
14,000
40.00
2.C.c
14,000
40.00
3.A.b
20,000
46.67
1.A.a
14,000
46.67
2.A.b
21,000
47.27
4.B.b
26,000
47.50
2.B.c
19,000
47.50
3.B.c
19,000
51.43
3.C.b
18,000
54.55
4.A.b
30,000
58.00
1.A.b
14,500
58.00
4.B.c
29,000
62.86
3.A.c
22,000
65.71
2.A.c
23,000
68.89
4.A.c
31,000
71.43
1.A.c
15,000
72.00
3.C.c
18,000
Cum
Volume
600
1250
1750
2300
2950
3400
4150
4600
5050
5400
5750
6100
6600
6900
7350
7900
8300
8700
9050
9600
9850
10350
10700
11050
11500
11710
11960
Price
27.50
27.69
34.00
34.55
36.92
37.78
38.67
38.89
40.00
40.00
40.00
40.00
40.00
46.67
46.67
47.27
47.50
47.50
51.43
54.55
58.00
58.00
62.86
65.71
68.89
71.43
72.00
A Supply/Cost Curve Example
80.00
70.00
3.C.c
1.A.c
4.A.c
2.A.c
3.A.c
60.00
1.A.b 4.B.c
4.A.b
50.00
Price Per Unit
10
3.C.b
1.A.a
4.B.b
2.A.b
2.B.c
3.B.c
40.00
4.B.a
3.C.a
4.A.a
3.B.b
2.C.c 3.A.b
2.C.a
2.C.b
2.B.b
2.B.a 2.A.a
30.00
3.B.a
3.A.a
20.00
10.00
0.00
0
2000
4000
6000
8000
Cumulative Market Quanity
10000
12000
14000
11
Mining Example
http://www.snl.com/Sectors/MetalsMining/MineEconomics.aspx
Supply Shifts
P
6
P
$5
Qs
60
4
50
3
35
2
20
1
5
Price (per bushel)
5
S3
S1
Change in Quantity
Supplied
S2
4
3
2
Change in Supply
1
0
10
20
30
40
50
60
Q
70
Quantity Supplied (bushels per week)
12
13
What causes supply to shift?*
•Number of sellers
•Anything that shifts marginal costs:
•Resource prices
•Technology
•Taxes and subsidies
•Prices of other goods (opportunity costs)
•Producer expectations
* Shift means more/less cost for any quantity,
or produce more/less at any price?
14
Producer Profits
Producer Profits
S = Cost on each
incremental unit of
Production
Price
P*Q = Revenue
P1
Producer Costs
Q1
Quantity
15
Sensitivity of supply
•Note, the shape is measuring the responsiveness of cost to changes in
quantity supplied
•Inversely, the shape reflects the responsiveness of quantity supplied to
changes in price
•What economists call “price elasticity” of demand
EsX=
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product X
16
Cross Price elasticity of supply
EsXY=
Percentage Change in Quantity
Supplied of Product X
Percentage Change in Price
of Product Y
•Elasticity > 0, production complements ….. Examples?
•Elasticity < 0, production competitors …. Examples?
17
Price Elasticity of Supply
Extreme cases
Examples?
• Perfectly inelastic supply
• Perfectly elastic supply
• Unitary Elasticity
p
S
p
p
S
Q
Price Elast of Supply = 0
S
Q
Price Elast of Supply = Inf.
Q
Price Elast of Supply = 1
18
What influences slope of supply
•Shape of curve for inputs
•Diminishing returns
•Time
•Market period
•Perfectly inelastic supply
•Short run
•Fixed plant size
•Long run
•Adjustable plant size
•Supply more elastic
19
Law of Diminishing Returns
(1)
Units of the
Variable Resource
(Labor)
0
1
2
3
4
5
6
7
8
(2)
Total Product
(TP)
0
10
25
45
60
70
75
75
70
]
]
]
]
]
]
]
]
(3)
Marginal Product
(MP),
Change in (2)/
Change in (1)
10
15
20
15
10
5
0
-5
Increasing
Marginal
Returns
Diminishing
Marginal
Returns
Negative
Marginal
Returns
(3)
Average
Product
(AP),
(2)/(1)
10.00
12.50
15.00
15.00
14.00
12.50
10.71
8.75
Total Product, TP
Law of Diminishing Returns
30
TP
20
10
0
Marginal Product, MP
20
20
1
2
3
Increasing
Marginal
Returns
4
5
6
7
8
9
Negative
Marginal
Returns
Diminishing
Marginal
Returns
10
AP
1
2
3
4
5
6
7
8
MP
9
Diminishing Returns Yields Increasing
Costs
Production Curves
Average Product and
Marginal Product
AP
MP
Quantity of
Labor
MC
Cost (Dollars)
21
AVC
Cost Curves
Quantity of Output
22
Fundamentals of market Analysis
• Know the number of potential consumers
• Know the sensitivity of consumption to changes in price
• Identify and track the factors that can shift demand and/or
change price sensitivity
• Know all potential sources of supply
• Know the cost of each increment of potential supply
• Estimate the responsiveness of supply quantity to changes in
price
• Identify and track the factors that can shift supply and/or
change price sensitivity
THINK MARGINALLY,
CLEARLY THINK THRU MARKET VS SHORT VS LONG RUN
Market Outcomes
Executive MBA 512
Session #11, November 17, 2016
Brian Greber
23
Today’s Objectives
• Review the classical “competitive” market and why it is
believed to be “good”
• Enable a structured approach to thinking through
trends, cycles, and fluctuations in market prices and
quantities.
• Discuss exceptions to the competitive markets and
their implications.
• Place these concepts into a strategic planning
framework.
24
25
Putting D&S together
•The meeting of
the minds that
balances price and
quantity
•What happens if
you instill quotas,
price ceilings, or
floors?
Market: Broad Definition
An actual or nominal place where forces of demand and supply operate,
and where buyers and sellers interact (directly or through
intermediaries) to trade goods, services, or contracts or instruments,
for money or barter.
Markets include mechanisms or means for (1) determining price of the
traded item, (2) communicating the price information, (3) facilitating
deals and transactions, and (4) effecting distribution. The market for a
particular item is made up of existing and potential customers who
need it and have the ability and willingness to pay for it.
Read more:
http://www.businessdictionary.com/definition/market.html#ixzz2iTw
EbPzz
26
Efficient Markets
• Economists’ “Holy Grail Is Efficiency”
• A solution is more efficient if we can make one party better off
without making others worse off.
• Optimal efficiency is achieved when we can no longer make one
party better off without making the other worse off,
• Efficiency assumes that the “gainer” could share his/her gains
with a “loser” to preserve their position, but does not require.
• Efficient Markets
• Allow informed meeting of the minds on prices and quantities by
buyers and sellers that have reasonable alternatives and
inconsequential impacts on individuals outside of the transaction.
• The Invisble Hand…
27
5-27
Efficient Market System Characteristics
• Private property
– Yields investment, innovation, exchange, maintenance, & growth.
• Freedom of enterprise and choice
– Scalability, Entry and exit
• Competition -- options
– More “checks and balances”
• Information supports pursuit of self-interest
– Creates “checks and balances”
• Markets and prices
– Coordinating mechanism for millions of trade-offs
• Monetary and banking system
– Insures medium of exchange
– Provides investment capital
28
Pure Competition ?
“Competition is the life force of
the free market system.
Competition between sellers
keeps prices from rising too
high. Competition between
buyers keeps prices from falling
too low. The resulting inbetween price is perfect in the
sense that it gets everyone to
do the right thing.”
Mathews.
29
Consumers receive value greater
than costs!
Price (Per Bag)
Consumer
Surplus
Price = $8
P1
D
Q1
Quantity (Bags)
30
Producers receive profits = P-C!
Price (Per Bag)
S
Producer
Surplus
Price = $8
P1
Q1
Quantity (Bags)
31
Competitive Equilibrium is Good!
S
Price (Per Bag)
Consumer
Surplus
Equilibrium
Price = $8
P1
Producer
Surplus
D
“Equilibrium is a condition or
state in which economic
conditions are balanced”.
Sharma and Pathan
Q1
Quantity (Bags)
32
Equilibrium
“P + Q remain unchanged from their
equilibrium values in the absence of external
influence” . Sharma and Pathan
How long do you think that is?
33
What happens when S&D
shifts
Effects of Changes in Both Supply and Demand
Change in Supply
Change in Demand
Effect on Equilibrium
Price
Effect on Equilibrium
Quantity
1. Increase
Decrease
Decrease
Indeterminate
2. Decrease
Increase
Increase
Indeterminate
3. Increase
Increase
Indeterminate
Increase
4. Decrease
Decrease
Indeterminate
Decrease
34
35
Failure 1:
Limited Competition
Barriers to Entry
•Economies of scale
•Legal barriers to entry
•Patents
•Licenses
•Ownership or control of essential resources
•Capital intensity
•Pricing and other strategic barriers to entry
36
Market Structure (Models)
Market Structure Continuum
& exit
Demand to
firm
Perfecty
elastic –
Price taker
P+ Q Volatile
Nearly Perfectly
elastic –
Price taker
P+ Q Volatile,
“Mark-up” P’s
“Marketing leakage”
Typically
“kinked”
P+ Q Sticky,
Inefficient
Downward
sloping =
market D
P+ Q Static,
P High,37Q low
Inefficient
Prone to Regulation
Monopoly Fundamentals
• Why do monopolies exist?
• Natural
• Regulatory
• Monopoly Problem.
• Outcome (assuming no cost advantage):
• Lower Quantity
• Higher Price
• Disproportionate allocation of market value to producer profits
• Inefficiency compounded when monopolist price discriminates
• Monopoly vs Monopsony
• One seller versus one buyer
38
Monopoly Problem to an
Economist
Pure
Monopoly
Purely
Competitive
Market
S=MC
MC
b
Pm
P=MC=
Minimum
ATC
Pc
c
Pc
a
D
D
MR
Qc
Qm
Qc
Pure competition is efficient
Monopoly is inefficient
39
7-39
5-39
Oligopoly Fundamentals
• A few large producers – enabled by entry barriers
• Four-firm concentration ratio
• Needs to be more than 40%
• Half of U.S. manufacturing
• Collusion is mutually beneficial
• Enhances profit
• Incentive to cheat
• Sans collusion gives rise to “kinked demand curve”
• Raise price, others don’t follow, big loss in share
• Lower price, others follow to preserve share
• In either case, prices and quantities are sticky and inefficient.
40
Oligopoly: Kinked Demand
Can be complicated – simple version …
Price and Costs
Rivals Ignore
Price Increase
D2
P0
e
Rivals Match
Price Decrease
D1
0
Q0
Quantity
MR1
41
7-41
5-41
Oligopoly: Price Outcomes
•
•
Price
Wait for the “first to move” then follow
Less frequent price changes than competitive markets
Competitive
Market
Oligopoly Market
Price
Time
Time
5-42
42
Pricing Examples
Pulp – a relatively
concentrated
industry
Lumber – a highly
competitive industry
43
Measures of Concentration
• X-firm Concentration Ratio
– % of Industry Output Accounted for by X largest firms
• Herfindahl Index
– Sum of squared shares of firm outputs within the industry.
• 1 firm HI = 1.02 = 1.0
• 4 firms equal output = 0.252 + 0.252 + 0.252 + 0.252 = 0.25
• 10 firms equal output = 0.12 + 0.12 + 0.12 + 0.12 ….. = 0.10
• 5 firms, unequal = 0.82 + 0.052 + 0.052 + 0.052 + 0.052 = 0.65
– Sometimes done in % terms (means HI tops out at 10,000)
– Critical in assessing mergers
• FTC looks close at industries with HI over 0.18 (1800)
• FTC looks close at mergers increasing HI by 0.01 (100)
44
Low Concentration Industries
(1)
Industry
(2)
4-Firm
Concentration
Ratio
(3)
Herfindahl
Index
(1)
Industry
(2)
4-Firm
Concentration
Ratio
(3)
Herfindahl
Index
14
114
Asphalt paving
25
207
Metal windows and
doors
Plastic pipe
24
262
Women’s dresses
13
84
Textile bags
24
263
Ready mix concrete
11
63
Bolts, nuts, and rivets
24
205
Wood trusses
10
50
Plastic bags
23
240
Stone products
10
59
Quick printing
22
319
Metal stamping
8
31
Textile machinery
20
206
Wood pallets
7
24
Sawmills
18
117
Sheet metal work
6
25
Jewelry
16
117
Signs
5
19
Curtains and draperies
16
111
Retail bakeries
4
7
45
High Concentration Industries
(1)
Industry
Primary copper
(2)
4-Firm
Concentration
Ratio
(3)
Herfindahl
Index
99
ND
(1)
Industry
(2)
4-Firm
Concentration
Ratio
(3)
Herfindahl
Index
Petrochemicals
85
2662
83
1901
Cane sugar refining
99
ND
Small arms
ammunition
Cigarettes
95
ND
Motor vehicles
81
2321
Household laundry
equipment
93
ND
Men’s slacks and jeans
80
2515
Beer
91
ND
Aircraft
81
ND
Electric light bulbs
89
2582
Breakfast cereals
78
2521
78
2096
Glass containers
88
2582
Household vacuum
cleaners
Turbines and
generators
88
ND
Phosphate fertilizers
78
1853
Tires
77
1807
Electronic computers
76
2662
Alcohol distilleries
71
Household
refrigerators and
freezers
85
1986
Primary aluminum
85
ND
46
1609
Failure 2:
Externalities
47
Inefficient Equilibrium:
Externalities
48
Inefficient Equilibrium: Externalities
P
P
Negative
Externalities
St
St
Positive
Externalities
S
Dt
D
D
Overallocation
0
Qo
Qe
Negative
Externalities
Q
0
Underallocation
Qe
Qo
Q
Positive
Externalities
49
Failure 3:
Asymmetric Information
P
P
Hidden costs
St
St
Misrepresented
benefits
S
Dt
D
D
Overallocation
0
Qo
Qe
Q
0
Overerallocation
Qo
Qe
Q
Consider:
What happens when University misinform about employability of a
major? Success or earnings potential.
What happens when consumer lies on insurance forms?
50
Failure 4:
Ill-conceived interference
51
Price Ceilings and Quotas:
Inefficient!
P
S
Examples?
$3.50 P0
ceiling
3.00 PC
D
Shortage
Qs
Q0
Qd
Q
Price Ceilings: Inefficient!
P
S
A = Transfer in value
(profit) from producer to
consumer
B = “unrecovered” loss of
profits to producers
$3.50 P0
ceiling
A
C = “unrecovered”
consumer loss from
shortage
B
C
3.00 PC
B+C = Deadweight loss
D
Shortage
Qs
Q0
Fairer?
Qd
Q
Price Floors: Inefficient!
P
S
Surplus
floor
$3.00 Pf
Examples?
2.00 P0
D
Q
Qd
Q0
Qs
Price Floors: Inefficient
P
S
Surplus
floor
A = Transfer in value
(profit) from consumer to
producer
$3.00 Pf
B = “unrecovered” loss of
profits to producers
A
C
2.00 P0
C = “unrecovered”
consumer loss from
higher price
B
B+C = Deadweight loss
D
Fairer?
Q
Qd
Q0
Qs
Failure 5:
Swings and SWAGs
56
Trend, Cycle& Seasons
Price or
Quant
Trend
Trend
& Cycle
Time
Market Trends:
Inertia/Momentum causes supply/demand to
continually shift through time
• What types of demand factors
are apt to continuously shift
through time?
• What type of supply factors are
apt to continuously shift through
time?
Caution: These continuous shifts
may or may not give rise to an
obvious price or quantity trend
58
Market Cycles:
Imperfect Information and Expectations
Causes “Oscillations” in Prices, Outputs,
and Inventories
• How do I know what price to
charge?
• What happens if I charge too much?
• What happens if I charge too little?
• What actually happens in the market
is sometimes called “the cobweb
effect”
59
Market Cycles:
Imperfect Information Causes “Oscillations” in
Prices, Outputs, and Inventories
Price/
Production Q
Inventory
Time
60
Market Shocks: One time events,
start the cobweb, again!
Price/
Production Q
Inventory
Time
EXAMPLES????
61
Porter’s 5 Forces
• A disciplined approach to defining markets in
business terms
• Really an economic approach to thinking
about competitive dynamics…..
62
Factors influencing
degree of competition
in your industry
Shape of industry
supply curve and
other cost
considerations
Dynamics of the
“shoot-out” &
P+Q thru time
Shape of industry
demand curve and
other demand factors
63
Assignment: due 11/28/2016
Using your commodity from the first assignment find at least 7 years of historic
monthly or quarterly price and quantity history for that good. Provide 2 Excel graphs
– one of quantity through time and one of price through time.
• Be sure all columns and graphs are clearly labeled and sources cited.
• Be sure to format the data tab and the graph pages so they can print out in a
well formatted way on one page each.
Identify trends, cycles, and fluctuations and discuss what may have caused them.
Specify whether they were demand shifters or supply shifters. I am looking for
“likely” reasons for trends, cycles, and “shocks”; not a statistical analysis.
Review your understanding of Porter’s Five Forces for this product/industry ( Barriers
to Entry, Threat of Substitutes, Buyer Power, Supplier Power, and Resulting Rivalry)
and relate this to the observed price and quantity behavior. Have 5 separate
sections in this write-up (one for each Porter block) – conclude with “This would
imply ….. for pricing through time and would imply ….. for quantities supplied
through time”. 1500 word MAX.
64
5-64