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Flashcards in Suppliers and Cost Deck (22)
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Willingness to sell is the

minimum amount of money that a supplier is willing to accept in return for the input it sells (e.g., labor, machines, other forms of capital). This is typically viewed from the standpoint of a firm – the WTP is consumer willingness to pay for the firm’s completed product, and WTS is its suppliers’ willingness to sell the inputs it needs.


The value created by a firm is the

difference between the WTP of its consumers and the WTS of its suppliers. The difference between the price that it charges its consumers and the price it pays its suppliers (also referred to as the firm’s cost) is its profit, or value captured by the firm.


The difference between WTP and price is the

Value captured by the consumer, or consumer surplus. The difference between the firm’s cost and WTS of its suppliers is the value captured by the supplier, or supplier surplus.


Fixed costs are costs

Fixed costs that have already been incurred (at the time that the firm is making a production or pricing decision) are called “sunk costs,” and should not impact decision-making.


Variable costs

Variable costs are costs that do vary with the level of production.


Relative cost analysis is the analysis of

how a firm’s costs compare to its competitors for each activity in its business. Relative cost analysis is most useful when calculated on a per-product basis.


A firm’s total costs are__

the sum of its fixed costs and its total variable costs.


A firm’s average total cost is its ___

total cost divided by the total volume of goods produced.


Opportunity cost =

Opportunity Cost = Value of foregone opportunities

what else could you have done with that resource? E.g. rent that has since increased in the area;


There are three steps to a relative cost analysis:

First, understanding your costs.
Second, estimating your competitor’s cost—which can require a fair amount of creative or “detective work,” as Professor Rivkin describes.
Third, using the relative cost estimates to explore how decisions are affected. These could be decisions about whether or not to enter a business (are your costs low enough), about whether you can compete in a price war, about where your advantage really comes from, and so on.


Once a plant is already in operation, which costs determine whether it makes sense for a plant to produce aluminum at a given price?

Variable costs
Once the plant is built, only the variable costs should be taken into account when deciding whether to produce.


As an incumbent considering whether or not to produce, you’d compare

your variable costs to the variable costs of the least efficient producer.


As an entrant considering whether entry is profitable, you’d compare

your average costs to the variable cost of the least efficient producer.


An entrepreneur is seeing if he should enter into a new market. His new plant would have double the capacity of the other plant currently in the market. He estimates that his average cost per product will be $400, $200 of those variable costs. He estimates that the other plant currently in the business has average costs of $600, $300 of those variable costs. Should he build his plant?

He should not build the plant.

Since his average costs are higher than the incumbent company's variable costs, he should not enter the industry. If the entrant tried to do so, the incumbent could drop prices down to its own marginal costs.



Profits=(Price Per Unit−Cost Per Unit)∗Quantity Produced


high fixed cost businesses are referred to as =

“volume businesses.” To recover fixed costs, you need greater volume.


Fixed costs are endemic to business, as we’ve seen in this module so far. And, fixed costs create scale economies that benefit them. The larger you are, the

more easily you can spread your fixed costs across more customers. As a result, your average costs are lower than rivals who are smaller.


Such businesses typically have very high minimum efficient scales of operation.

Such businesses need to produce large volumes to spread their fixed costs over large volumes in order to have any chance of recovering their large fixed investments.

What concept does this explain?

“volume businesses"


A supply curve describes

how much of a good a supplier will be willing to provide at each price.


“Economies of scale” result from

firms being able to spread their fixed costs over larger units of production. Industries with high levels of fixed costs are therefore more attractive if a firm knows that it can produce at large scale, since it can spread these costs over many units. Industries with high fixed costs are also likely to have fewer firms competing in them. Industries with low fixed costs are easier to enter and have a low minimum efficient scale.


In a price war, a firm should be willing to price as low as its

variable cost-per-unit.


A price ceiling is set at 10% below the market equilibrium price. What happens to

producer surplus;
total surplus;
deadweight loss;

Producer surplus decreases
Under the price ceiling, fewer consumers are purchasing the good and they are each buying it at a lower price. Both effects lower producer surplus.

Total surplus decreases
Total surplus is WTP – WTS for each item sold. Under the price ceiling, the WTP and the WTS are not changing, but the number of items sold has decreased. Thus, total surplus has decreased.

Total surplus decreases
Total surplus is WTP – WTS for each item sold. Under the price ceiling, the WTP and the WTS are not changing, but the number of items sold has decreased. Thus, total surplus has decreased.