Chapter 7

Chapter 7 -Main points

• The law of diminishing marginal returns states that as
you try to expand output, your marginal productivity (the
extra output associated with extra inputs) eventually
declines.
• Economies of Scale
• Economies of Scope
• Learning Curves
 Rayovac Company
• Founded in 1906, three entrepreneurs started a battery
production company that grew to rival Energizer and
Duracell.
• In 1996, The Thomas H. Lee Company acquired Rayovac
– taking advantage of easy credit availability the company
then bought many other battery production companies as
well. A move the company said they made to take
advantage or efficiencies and economies of scale.
• They expected that as they produced more of the same
good, average costs would fall.
• The company also bought many unrelated companies at
the same time as the battery binge – the reasoning being
that because of synergies, if they centralized the production
of many different goods the costs of production would be
lower.
• By February 2009 the new conglomerate was bankrupt
• Moral of the story? In business investments if you hear
the words efficiency or synergy, keep your money.
 Increasing marginal costs
• The law of diminishing marginal returns: as you try to
expand output marginal productivity eventually declines.

• Diminishing marginal returns  marginal productivity declines

• Diminishing marginal productivity  increasing marginal costs
• Increasing marginal costs eventually lead to increasing average costs
• Some causes of diminishing marginal returns
 Difficulty of monitoring and motivating a large work
force
 Increasing complexity of a large system
The “fixity” of some factor, like testing capacity
Marginal cost
marginal vs. average cost
 Akio Morita and the Sony Transistor radio
• In 1955, Akio Morita brought his newly invented $29.95
transistor radio to New York.
• The problem was that the retailer had a chain of around
150 stores and wanted to buy 100,000 radios, 10 times
more than Mr. Morita’s capacity.
 Economies of Scale
• A proportionate saving in costs gained by an increased
level of production.
– Factors that are fixed costs in the SR but become variable in the long
run.
• If long-run average costs are constant with respect to
output, then you have constant returns to scale.
• If long-run average costs rise with output, you have
decreasing returns to scale or diseconomies of scale.
• If long-run average costs fall with output, you have
increasing returns to scale or economies of scale.
• Economies of scale have had a dramatic effect on the
structure of the poultry industry in the United States. In
1967, a total of 2.6 billion chickens and turkeys were
processed in the United States.
• By 1992, that number had increased to nearly seven
billion.
• The number of processing facilities dropped from 215 to
174.
• The share of shipments of plants with over 400
employees grew from 29% to 88% for chicken production
and from 16% to 83% for turkey production over the same
period.
 Economies of Scope
• If the cost of producing two products jointly is less than
the cost of producing those two products separately then
there are economies of scope between the two
products.
 Gibson Guitar
• Gibson Guitar produces guitar fingerboards
• Rosewood is used for budget guitars
• Ebony is used for high-end guitars
• However, there is a decreasing supply of ebony
• Brown streaks in ebony are seen as a blemish for high-
end guitars, but a step up from rosewood.
• The streaked ebony can be used on budget guitars
• Better than rosewood cost and quality advantage
• Simple formulas, e.g., Cost=Fixed +(mc)*quantity, don’t
work with economies of scope or scale.
 Diseconomies of scope
• Production can also exhibit diseconomies of scope
when the cost of producing two products together is
higher than the cost of separate production.
 AnimalSnax, Inc
• Has 2,500 products (SKU’s) with 200 different formulas
• They receive a lot of pressure from large customers like
Wal-Mart to reduce prices.
• To respond to Wal-Mart, the company shrinks it product
offerings
• 70 SKUs w/13 formulas
• This led to a 25% savings for the company because of
reduced production costs (see graph)
 Learning Curve
• Learning curves are characteristic of many processes.
That is, when you produce more, you learn from the
experience; then, in the future, you are able to produce at
a lower cost.
Every time an airplane manufacturer doubles production, marginal cost decreases by 20%
Chapter 8
 Chapter 8 -Main points
• A market has a product, geographic, and time dimension.
Define the market before using supply–demand analysis.
• Demand Curves
• Supply curves
• Market equilibrium
• Prices are a primary way that market participants
communicate with one another.
 Y2K and generator sales
• From 1990-98, sales of portable generators grew 2%
yearly.
• In 1999, public anticipation of Y2K power outages
increased demand for generators.
• Walters, Rosenberg and Matthews invested to increase
capacity in anticipation of this demand growth – they
vertically integrated their company to increase capacity
and reduce variable costs.
• Demand grew as expected - Industry shipments
increased by 87%. Prices also increased by an average of
21%.
• Demand fell back to 1998 levels, and prices tumbled to
below-1998 levels.
 Which industry or market?
• Every industry or market has a time, product, and
geographic dimension.
• For example: The yearly market for portable generators in
the U.S.
• Time: annual
• Product: portable generators
• Geography: US
 Shifts in the demand curve
• Movement along the demand curve indicates the “quantity
demanded” increased.
• Shifts in demand curve can occur for multiple reasons
• Uncontrollable factor – affects demand and is out of a
company’s control.
• Controllable factor – affects demand but can be controlled by
a company
 Microsoft
• In the late 1970s, Microsoft developed DOS, an operating
system to control IBM computers.
• To increase demand for DOS Microsoft:
Licensed its operating system to other computer
manufacturers
Developed its own versions of complimentary
products
Kept the price of DOS low
Demand increase
 Supply curves
• Supply curves are functions that relate the price of a
product to the quantity supplied by sellers.
 Market equilibrium
• Market equilibrium is the price at which quantity supplied
equals quantity demanded.