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PowerPoint Diagram Pack

Industry Supply Curve Analysis

Industry Supply Curve Analysis is a visual representation of the Law of Supplyand provides insight into competitive pricing and production dynamics. Also includes Cost Curve Analysis (ATC, AFC, AVC, Breakeven Point, and Shutdown Points).
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UNIT PRODUCTION COST Old Market Price New Market Price

Added Capacity

Contents
Overview - Benefits & Limitations Cost Curve Analysis - Overview - Cost Curves Supply Curve Analysis - 10-Step Approach - Example 4 6 7 8 9 11 12 24

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representation of the Law of Supplyand provides insight into competitive pricing dynamics
Supply Curve Analysis Overview
The Industry Supply Curve is graphic representation of the Law of Supply, which states that there is a direct relationship between price and quantity supplied. The Supply Curve slopes upward to the right. The slope tells us that the quantity supplied varies directly with price. Analyzing the Industry Supply Curve also provides insight into competitive pricing dynamics and helps with scenario-based game analysis. The example provided at the end of this document illustrate the impact to price and competition as one player decides to change its production capacity. INDUSTRY SUPPLY CURVE
UNIT PRODUCTION COST

Long-run Industry Supply Curve

Short-run Industry Supply Curve

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Segment 1 Segment 2 Segment 3 Segment 4 Seg 5 S6

CUMULATIVE PRODUCTION

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Formulation and understanding of Industry Supply Curves is dependent on Cost Curve Analysis
Cost Curve Analysis Overview Cost Curves are used to illustrate the relationship between production costs and production capacity
KEY DEFINITIONS
Total Cost of Production (TC) This includes all costs associated with the delivery of value to the customer; e.g. transportation, installation, guaranteed service, etc. These costs can broken down into Fixed Costs (FC) and Variable Costs (VC) Average Total Cost = (FC + VC) / quantity produced Fixed Costs (FC) These costs are not tied to level of goods produced; e.g. plant maintenance, overhead, utilities, land, leases, insurance Average Fixed Cost (AFC) = FC / quantity produced

KEY TRENDS/CONCEPTS
As production increases, the AFC per unit begins to fall as fixed costs are spread across an increasing number of units As production increases, the AVC will initially decrease as increase in production leads to economies of scale (e.g. bulk discounts in raw materials)however, after a certain a point, the AVC will begin to increase as production experiences diseconomies of scale (e.g. more employees, trucks) experience economies of scale, but will eventually increase as diseconomies of scale kick in Curves

As a result, the ATC THIS IS A PARTIAL PREVIEW per unit falls initially as companies

Variable Costs (VC) These costs are dependent directly on the quantity of good products; e.g. raw materials, wages/salaries, packaging, shipping Average Variable Cost (AVC) = VC / quantity produced

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Two important points to identify on the Cost Curves are the Breakeven Point and Shutdown Point
Cost Curves MC, Breakeven Point, Shutdown Point
Marginal Cost (MC) the cost of producing 1 unit

UNIT PRODUCTION COST

ATC

AVC

Breakeven Point is the value when MC = minimum ATC At this point, the company makes no money on the produced goods

MC

Breakeven Point
Shutdown Point is the value when MC = minimum AVC At this point, the company is operating at a loss and is indifferent from continued operations or shutting down temporarily

THIS IS A PARTIAL PREVIEW Shutdown

AFC Point

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PRODUCTION QUANTITY

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Step 5 Determine the total production cost for each competitor group
Overview
Use your companys detailed cost data to develop a cost model Perform high-level activity based costing (ABC)to do this, map your companys product and delivery processes; and assign relevant costs to each Assess the production differences experienced by the representative firms in other segmentsthis is done by estimating how the production process of each representative firm may differ from your own processes (e.g. machine technology, labor productivity, plant site location, delivery costs, warehousing costs, etc.) The production costs of each competitor group should be assimilated based on the totalTHIS IS A PARTIAL PREVIEW production cost components (e.g. labor, raw materials, overhead, delivery) for that product or service In other words, sum up all such Component Costs, where Component Cost = (Cost of Input) x (Quantity of Input)
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Define the industry and market boundaries. Determine the industry structure. Group producers into segments. Select a representative producer within each segment. Determine the total lifetime production cost for each representative producer. Separate the fixed costs and variable costs for each segments representative producer. Calculate the points of the representative firms Cost Curves. Determine the total production capacity of each segment. Plot the Industry Supply Curve. Verify the resulting Industry Supply Curve.

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Step 6 Separate fixed costs and variable costs for competitor

Overview
You need to separate fixed costs from variable costs to correct calculate and create the Cost Curves (and eventually the Industry Supply Curves) The separation of costs into fixed and variable costs is necessary for finding the Shutdown Point The long-run Industry Supply Curve, however, can be created with just the total costs This is done by determining which costs related to the production and delivery of the product or service do not fluctuate with the level of production Fixed costs are incurred even if production equaled zero
1 2 3 4 5 6 7 8 9 10
Define the industry and market boundaries. Determine the industry structure. Group producers into segments. Select a representative producer within each segment. Determine the total lifetime production cost for each representative producer. Separate the fixed costs and variable costs for each segments representative producer. Calculate the points of the representative firms Cost Curves. Determine the total production capacity of each segment. Plot the Industry Supply Curve. Verify the resulting Industry Supply Curve.

THIS IS A PARTIAL PREVIEW

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Step 7 Calculate the points of the representative companys cost curves

Overview
Assuming the representative company is producing at maximum/full capacity, calculate the following: Average Total Cost ATC = (VC+FC) / (total quantity produced) Average Fixed Cost AFC = FC / (total quantity produced) Average Variable Cost AVC = VC / (total quantity produced)
1 2 3 4 5 6 7 8 9 10
Define the industry and market boundaries. Determine the industry structure. Group producers into segments. Select a representative producer within each segment. Determine the total lifetime production cost for each representative producer. Separate the fixed costs and variable costs for each segments representative producer. Calculate the points of the representative firms Cost Curves. Determine the total production capacity of each segment. Plot the Industry Supply Curve. Verify the resulting Industry Supply Curve.

THIS IS A PARTIAL PREVIEW You can preview the full PowerPoint document and download it at http://learnppt.com/powerpoint/

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Segment 3 can aggressively increase capacity to push out Segment 4

Industry Supply Curve Analysis Example (cont.)
Segment 3 can drive out Segment 4 by increasing capacity past the Market Demandthis will also lower the overall Market Price (and therefore erode margins).
UNIT PRODUCTION COST

Market Demand

Overcapacity
ATC AVC

Old Market Price New Market Price

The New Market Price would likely fall to just below the AVC of Segment 4

THIS IS A PARTIAL PREVIEW

Added Capacity

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Segment 1 Segment 2 Segment 3 Seg 4 Segment 5 S6

CUMULATIVE PRODUCTION

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END OF PARTIAL PREVIEW You can preview the full PowerPoint document and download it at http://learnppt.com/powerpoint/

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