Archive for the 'Costs of production' Category

Feb 28 2012

Rising costs and falling demand put the pinch on the food delivery industry

Gas pushes up cost for Triangle delivery restaurants – Economy – NewsObserver.com

Read the article below and answer the discussion questions that follow:

Do you love the convenience of having your pepperoni pizza or egg foo young delivered right to your door?

If gas prices continue to rise in the next few months, it might cost you more for the privilege depending on where you order.

Triangle-area delivery restaurants worry about the impact higher gas prices could have on their businesses. It’s a concern that is felt among these restaurants nationwide.

On Sunday, the average price for regular unleaded gas in North Carolina was about $3.71, according to AAA. The website raleighgasprices.com listed prices as low at $3.54 in Fuquay-Varina and as high as $3.89 in Cary.

HotBox Pizza on Hillsborough Street charges $2 for a delivery to help offset the costs of gas for its drivers. While owner James McCaskill said there are no imminent plans to raise that fee, he does worry that it could cost more to get food shipments in.

“For us to deliver the pizza, there’s a cost,” McCaskill said. “We have to pay for our drivers and the wear and tear on their car and essentially to help pay for the gas they use to deliver the pizzas.”

Bruno Rodriguez, owner of Amante Gourmet Pizza in Durham, said back in 2008 when gas hovered around $4 a gallon, the effects weren’t so bad because the hike was short lived. But he’s more worried about it in 2012 during a time when roughly 60 percent of his orders are for delivery.

“I think we’re coming slowly out of a recession, but I think with gas prices around $4, I think it’s going to be longer lived so that definitely will have an impact,” he said. “People will tend to not order many deliveries.”

Rodriguez said Amante charges $1.40 for deliveries in the Bull City, and he probably spends about $40 or $50 a week on gas for deliveries. Fortunately for him, he has a small Toyota, but he isn’t ruling out raising his delivery charge 20 or 30 cents if things get worse.

Shanghai Express, across from N.C. State University on Hillsborough Street, serves primarily college students.

“The economy is no good, so business definitely goes down,” said manager Jinlong Wang, who estimates about half of his orders are deliveries. “Their parents pay their tuition. But when economy no good, parents have no money and (students) have no money too.”

Many experts are debating whether gas could reach $5 a gallon by this summer. That could potentially cripple many businesses.

“If it stays there for too long, it will be a problem,” Rodriguez said. “I think sales are going to go down.”

Rodriguez said the key to keeping gas prices reasonable is not action by lawmakers in Washington, but in how all Americans act.

“It’s up to us to control how much we drive, how hard we drive, what kind of cars do we drive. I’m not sure Washington can do much except drill more in more dangerousplaces,” he said.

Discussion Questions:

  1. How do rising gas prices affect the short-run costs of running a delivery service for local restaurants in North Carolina?
  2. Why were the high gas prices in 2008 less of a concern that the rising gas prices in 2012 for these restaurants?
  3. Assume the restaurant delivery industry is perfectly competitive and at the beginning of 2012 was in a long-run equilibrium. Using two diagrams, one for the restaurant delivery industry and one for a single restaurant in the industry, illustrate the effect of rising gas prices on the individual firms in the short-run.
  4. Assume gas prices remain high throughout 2012 and into 2013. How will the industry adjust to higher gas prices in the long-run? Illustrate the long-run adjustment in your graphs.
  5. “The economy is no good, so business definitely goes down.” Which determinant of demand for restaurant meals is described here? How does the bad economy affect the restaurant industry and firms in the industry? In new diagrams, show the effect of the poor economy on the market and a single restaurant in the market

3 responses so far

Feb 27 2012

A closer look at Apple’s iPad and iPhone – “made in America”?

I have two  interesting stories on Apple and the iPad to reflect on today.

First, ABC’s Nightline recently became the first Western journalists actually welcomed into an Apple assembly plant in China. The show recently aired a 15 minute feature on working conditions inside Apple’s Foxconn factory in Shenzhen, China last week. Watch the video and then scroll down for what may be some additional surprising news about Apple’s operations in China.

Next, the story that has gone unreported lately is a University of California study titled “Capturing Value in Global Networks: Apple’s iPad and iPhone”. The study’s most interesting finding, in my opinion, is the tiny percentage of the total value of Apple’s iPhone and iPad that actually goes to the Chinese manufacturers of the products. The charts below, from the study, show how the value is divided among the various groups involved it their production and sales:

The Economist provides the analysis:

The chart shows a geographical breakdown of the retail price of an iPad. The main rewards go to American shareholders and workers. Apple’s profit amounts to about 30% of the sales price. Product design, software development and marketing are based in America. Add in the profits and wages of American suppliers, and distribution and retail costs, and America retains about half the total value of an iPad sold there. The next biggest gainers are South Korean firms like Samsung and LG, which provide the display and memory chips, whose profits account for 7% of an iPad’s value. The main financial benefit to China is wages paid to workers for assembling the product and for manufacturing some inputs—equivalent to only 2% of the retail price.

A student today asked why Apple doesn’t produce its products in the United States, where an economic downturn has left 14 million American out of work for the last three or four years. If iPads and iPhones were just made in America, jobs could be created, households would have more income to spend on Apples products, and both the country and the economy would benefit.

The data in the UC study indicates that in fact, more than half the value of an iPad or iPhone does end up in the hands of Americans. But Apple could never achieve the low costs and high profits that it does by assembling its products in the US. After watching the Nightline video above, it should be clear that the type of production involved in Apple factories’ is very low-skilled and labor-intensive. Using American labor, with its unions, minimum wages and 40 hour work weeks, would require Apple to employ such large numbers of workers and raise the company’s variable cost to such a level that the firm’s profits would be reduced significantly and its sales would fall dramatically. Apple would lose out to foreign producers of smart phones and tablet computers, such as LG, Samsung, Sony and others, which would continue assembling their goods with Chinese labor.

Ultimately, any gain to the low-skilled American workers (presuming Apple could even find enough to do the work of the 400,000 Chinese employed in the production of Apple products in China), would be offset by a loss of profits enjoyed by the millions of Americans who hold shares in Apple Computer and the thousands of American who are employed engineering and designing its products, as the firm’s sales would slip in the face of lower-cost competitors.

So this student’s question identifies an interesting paradox: America, with its large pool of unemployed workers, will never be attractive as a place to produce labor-intensive products such as phones and tablet computers, due to the vast wage differential between the US and China. And even if one firm did decide to produce its products in America, the gains to low-skilled workers who may find minimum wage work in the new assembly plants would be off-set by losses to the firms’ shareholders and the high-skilled workers whose jobs would be lost as sales decline due to the lower prices offered by lower-cost competitors.

The lesson here is two-fold: First, Apple and other American technology companies should continue using Chinese labor to assemble their products, and second, America is better off for it: lower costs mean cheaper products and higher sales, thus greater employment in the high-skilled sectors of the US economy, and more profits and returns on the investments of shareholders in American corporations. Americans are richer and enjoy a higher standard of living thanks to the millions of Chinese working in factories assembling the goods we consume.

Keep in mind, this analysis did not even consider the effect on the Chinese economy and the millions of Chinese workers (whose lives are much harder than the typical American) should companies like Apple shut down their Chinese manufacturing plants. That’s a whole other blog post!

2 responses so far

Sep 02 2011

How to have your pasta and eat it too – understanding the allocating function of prices in a market economy

Have a look at this article before reading the blog post below: Pasta prices rise after North Dakota loses million acres of wheat to heavy rain, flooding – Associated Press

Prices are determined by the relative scarcity of a good, service or productive resource. This fundamental lesson is one of the first things we learn in a high school economics class. Why are diamonds, which nobody really needs, so much more expensive than water, which everyone needs? The answer lies not in the relative demands for the two goods (clearly, water is far more demanded than diamonds), but rather the relationship between the relative demand and the supply. Between the two, diamonds are far more limited in supply than water, thus they are scarcer and accordingly more expensive.

This lesson applies not only to water and diamonds, but indeed to any product for which there is a market in which buyers and sellers engage in exchanges with one another. Commodities are goods for which there is a demand,  but for which the supply is standardized across all markets. For instance, bicycles are not a commodity, because there are hundreds of different types of bicycles, meaning it is not a standardized product. But steel, which is used to make bicycles, is a commodity since steel is fairly standard regardless of its ultimate use by manufacturers. Cookies are not a commodity, but wheat is, since wheat is a highly standardized ingredient used in the production of cookies.

Commodity prices, like the prices of anything, are determined in markets. Buyers are usually the manufactures of secondary products for which the commodities are an input. Since commodities are traded all over the world, there tends to be a common market price determined by the national or international supply and demand for the commodity. In recent weeks, one very important commodity has increased in scarcity, leading to an increase in the price for the finished product the commodity is used to produce.

Consumers are paying more for pasta after heavy spring rain and record flooding prevented planting on more than 1 million acres in one of the nation’s best durum wheat-growing areas.

North Dakota typically grows nearly three-fourths the nation’s durum, and its crop is prized for its golden color and high protein. Pasta makers say the semolina flour made from North Dakota durum produces noodles that are among the world’s best.

This year’s crop, however, is expected to be only about 24.6 million bushels, or about two-fifths of last year’s. Total U.S. production is pegged at 59 million bushels, a little more than half of last year’s and the least since 2006, according to the U.S. Department of Agriculture.

The cost of pasta jumped about 20 cents in the past few months to an average of about $1.48 a pound nationwide…

…North Dakota durum fetched about $15 a bushel this spring but has dropped to about $11, due to the lack of buying and selling.

Still, that’s about twice what it sold for at this time last year, she said…

“This is one of the few crops we have that can have such an immediate impact on the consumer,” Goehring said. “This year, they will experience higher pasta prices.”

The story above is one played out in countless markets for commodities (such as wheat) and the goods they are used to produce (pasta, in this case) all the time. Due to poor weather and a particularly wet spring, farmers were unable to plant as many of their fields with wheat as they have in the past. Therefore, the 2011 wheat harvest is less than it usually is, meaning the supply of wheat has decreased. However, since there has been no fundamental change to the demand for wheat (we still eat pasta!) the relative scarcity of wheat is greater than in the past. Demand remained constant, while supply fell, therefore the relative scarcity increased.

The value of anything is based on its relative scarcity. In product markets, like that for wheat, value is conveyed by the commodity’s price. As the article says, the price of wheat is currently selling at “about twice what it sold for at this time last year”. At the current price of $11 per bushel, we can assume that the price last year was $5.50. However, the price reached as high as $15 earlier in the summer, indicating that the reduced supply of 59 milliion bushels, which is “a little more than half of last years” (which we’ll assume was around 100 million bushels), caused the price to peak at $15 this year. All this is a complicated way of saying that as the output of wheat fell, wheat prices rose because demand remained constant.

Additionally, the price of the product for which wheat in an input also rose. Pasta prices have jumped “20 cents in the past few months” to $1.48. Since the price of wheat is a resource cost for pasta producers, higher wheat prices lead to a fall in the supply of pasta, making pasta more scarce and driving the price up for pasta consumers.

All this can be demonstrated graphically using simple supply and demand analysis.

Based on the figures in the graphs above, the responsiveness of wheat consumer (which are mostly pasta producers) to the rising price of wheat can be easily calculated. Price elasticity of demand (PED) is the measure of consumers’ sensitivity to price changes. It is measured by calculating the percentage change in quantity following a price change divided by the percentage change in price. The quantity demanded of wheat fell by 41%, while the price rose by 272%, meaning that the PED for wheat is 41/272, or 0.15. This is considered relatively inelastic since such a large price increase led to a relatively small fall in the quantity of wheat demanded.

It is likely that if wheat prices remain elevated throughout 2011, next spring farmers across the American Midwest will have a strong incentive to plant more acres of wheat than they have in years past. Assuming the weather conditions improve and the fields are dry enough to grow wheat, it would be expected that a year from now wheat prices will be much lower than they are today, as supply returns to or exceeds historical levels next year. High prices for wheat today have harmed pasta consumers, but in the long run everyone, both pasta producers and pasta consumers, will likely enjoy lower prices thanks to the high prices of today.

This is how the market system works. When resources are under-allocated towards a particular good, as they have been towards wheat in 2011, price rises in response to the good’s increased scarcity. But the higher prices incentivize producers to allocate more resources towards those goods’ production, and over time the supply increases once more, reducing its scarcity and bringing the price back down.

Discussion Questions:

  1. Why did wheat become more scarce in 2011, even though the demand for wheat did not change?
  2. Interpret the claim that “wheat consumers are relatively unresponsive to higher wheat prices”. Can you think of a reason why this is the case? Can you think of an example of a product for which consumers would likely be much more responsive to a change in the price?
  3. How does the high price of wheat and pasta in 2011 likely assure that a year from now, prices will be much lower than they are today, assuming there are not further problems with flooding in wheat growing areas?
  4. How do prices “allocate resources” in a market economy? What do you think would have happened to the number of acres farmers would plant in wheat next year if instead of the price doubling this summer, it had been half of what it was in previous years?

2 responses so far

Nov 24 2010

Lesson Plan: Costs of Production Presentation for Y1 IB Economics

Unit 2.3.1 Costs of Production: Team Presentation Activity

Learning Objectives:

  • Distinguish between fixed and variable costs of production
  • Understand how the law of diminishing returns affects the shape of a firm’s short-run total costs and short-run average costs.
  • Understand the relationships between marginal cost and the average costs faced by a firm
  • Distinguish between the short-run and the long-run and understand how economies of scale determines the shape of a firm’s long-run ATC curve.
  • Evaluate the importance to a business firm of understanding its short-run and long-run costs of production.

Process: Work with a partner in the class to prepare a presentation on the theories behind and the relationships between a firm’s short-run and long-run costs of production. Pairs will create a shared Google Presentation (which should also be shared with Mr. Welker) and collaborate on creating a presentation demonstrating your understanding of the topics outlined below. The presentations that are created will be shared among group members, and edited in class and over the weekend.

The assignment: Each team is to make one Google Presentation on an assigned topic based on what they learn using the web-resources provided by Mr. Welker below. Presentations will be shared with Mr. Welker and presented during our first meeting next week.

Guidelines for presentation:

  1. Presentations must be at least 10 slides long, but no more than 15.
  2. Presentations must include definition, explanations, illustrations and examples (when possible) for the key concepts identified below
  3. Presentations must include graphs from the resources provided to illustrate concepts where necessary
  4. Presentation must use each group’s own words. Copying and pasting text from the resources provided is not permitted.

Shor-run – Key Concepts

Resources on Short-run Costs of Production:

Long-run: Key Concepts

Resources on Long-run Costs of Production:

Grading Presentation: Total – 40 marks

Area of assessment

High marks (7-10)

Medium marks (4-6)

Low marks (1-3)

Organization Easy to read. Font size varies appropriately. Text is appropriate length. Presentation falls within the required length limits (10-15 slides) Overall readability is difficult. Too much text. Too many different fonts. Presentation falls within the required length (10-15 slides) Text is difficult to read. Too much text. Inappropriate fonts. Small font size. Presentation is either too short or too long.
Graphs All graphs are related to content. All graphs are appropriate size and good quality. Graphics are explained clearly and illustrate the concepts from the presentation Some of the graphs are unrelated to content. Too many graphics on one page. Some of the graphics distract from the text. Graphs are explained, but explanations are incomplete or unclear Most of the graphs are unrelated to content. Too many graphics on one page. Most of the graphs distract from the text. Explanations are incomplete and unclear
Concepts The economic concepts that were assigned have been completely and accurately incorporated into the presentation. Definitions, explanations, illustrations and examples fully reflect the team’s understanding of the concepts The economic concepts assigned are all addressed in the presentation, but analysis is superficial and lacks original insight from the team members. The economic concepts assigned are not all addressed in the presentation. One or more have been left out completely, and those that were addressed were explained or illustrated incorrectly.

Mark Bands:
27-30: A, 23-26: B, 19-22: C, 15-18: D, 0-15: F

5 responses so far

Nov 22 2010

From short to long: Economies of scale and the long-run average total cost curve

Look closely at the two cost curves below:

srATC

The curve on the left is a firm’s short-run average total cost curve. The one on the right represents a firm’s long-run average total cost curve. See the difference?

I didn’t think so. The shape of a typical firm’s short-run and long-run ATC curves may in fact be identical. But there are some very important differences to understand about the short-run costs and long-run costs faced by firms.

The Short-Run: In microeconomics, we define the short-run as the period of time over which a firm’s plant size is fixed. The only variable resource is labor and raw materials, meaning that when demand increases for a firm’s product, the firm is able to increase employee work hours, hire more workers and use existing capital more intensively, but it does not have the time to acquire new capital or expand factory size. Likewise, when demand falls for a firm’s products, it can cut back on work hours, fire workers, but cannot downsize its plants or factories.

The Long-Run: The long-run is defined as the variable-plant period. A firm can adjust the number of all its inputs: land, labor and capital. One way of thinking about the difference between the short-run and the long-run is imagining the long-run as several different short-runs spread out over a larger range of output. The graph below will illustrate this concept for you.

lrATC

When we examine the long-run ATC more closely, it becomes apparent that there are in fact lots of little short-run ATC curves along the length of the long-run curve. Each of the gray lines in the graph above represent a short-run period in which this firm opened a new factories. There are three distinct phases of this firm’s long-run ATC:

  • Economies of scale: As this firm first begins to grow and open new factories, it becomes better and better at what it is producing, is able to get more output per unit of input, and thus experiences lower and lower average total costs as it grows larger. “Scale” is a synonym for size. The bigger the firm’s size, the lower its costs of production: this is called “economies of scale”. My favorite illustration of the concept of economies of scale is to think about two shoe companies: Nike and Luigi’s Fine Italian Shoes. Nike makes shoes in giant factories in Indonesia, ships them in giant containers to all corners of the world in shipments containing 100,000 shoes each. Luigi makes shoes in his basement in Milan, has two employees, and ships shoes one at a time to customers around Europe. Who will have a lower average total cost of producing shoes? Luigi or Nike? Clearly, Nike has economies of scale, Luigi does not. If Luigi were to grow his business, chances are his average total costs would decline.
  • Constant Returns to Scale: For the firm above, economies of scale assure that the larger it becomes, the lower its average total costs get. Efficiency in production improves whether through the lower price of inputs achieved through bulk-ordering, its ability to attract and hire skilled managers, the lower per unit cost of shipping larger quantities of products, or other such benefits of being big. At a certain point, however, the benefits of getting larger begin to diminish. This firm’s tenth factory is its minimum efficient scale: The level of total output this firm must achieve to minimize its long-run average total cost. Beyond this level of production, as this firm continues to grow, it will see no further cost benefits; in other words, it will achieve constant returns to scale (size).
  • Diseconomies of scale: Why did the Mongol, the British and the Soviet empires collapse? Some historians argue it was because they became too big for their own good. When an organization (whether it’s a country or a firm) becomes TOO big, it begins to experience inefficiencies. When a firm grows so large that it has factories in all corners of the world, a dozen levels of management, and countless opportunities for corruption and miscommunication, its efficiency decreases and its average total costs begin to increase. In the 1980′s General Motor Company began to lose lots of business to smaller Japanese rivals. The outcome was the gigantic corporation broke up into smaller divisions, which then began to operate as different firms. For a while, GM remained competitive, partially because as a smaller firm, it was more efficient and able to compete on cost with its foreign rivals.

Diminishing Returns versus Economies of Scale: A common area of confusion for economics students is the difference between these two seemingly similar concepts. The difference lies in the two curves above, the short-run ATC and the long-run ATC.

  • The shape of short run costs (MC, ATC and AVC) are determined by the law of diminishing returns. Since short-run costs are determined by the productivity of the variable resource in the short-run (labor), diminishing returns assures that at first, since a firm can expect to get MORE output for additional units of labor (as fixed capital is used more efficiently) ATC declines as output increases. But beyond a certain point, diminishing returns sets in and the additional output attributable to more units of the variable resource declines. Inevitably, a firm will experience higher and higher average costs as its output continues to grow, since it’s only able to vary the amount of labor used, not capital.
  • The shape of long run ATC is determined by economies of scale (and diseconomies of scale). All resources are variable in the long-run, but lower costs cannot be guaranteed the larger a firm gets. At first, efficiency is improved as the firm grows, but at some point it becomes “too big for its own good” and costs start to rise as productivity of resources (land, labor and capital) is inhibited due to the firm’s massive size.

Discussion Questions:

  1. What does it mean that a firm can become “too big for its own good”? Can you think of any other organizations (economic or otherwise) that have gotten so big that they’ve failed?
  2. Why does your hometown have only one electricity company? Why aren’t utility industries such as water, natural gas, and garbage collection more competitive? How does the concept of economies of scale lead to certain industries being “natural monopolies”?
  3. Why don’t more companies make jumbo jets?

78 responses so far

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