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Firms and customers IMPA 612: Public Management EconomicsFebruary 12, 2018

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Current eventsNow expanded to take advantage of your new vocabulary!

Costs and profit

Demand and profit maximization

Outsourcing revisited

Plan for today

Popsicle Sticks, Inc.

OutsourcingWhen should government privatize stuff?

Conditions for contracting

The bigger the adverse consequences of cost-cutting on quality, the stronger the case for in-house provision

Should governments outsource…

Snowplows Garbage

Mail Schools

Prisons Police

Healthcare

Military

Demand and profit maximizationHow much stuff should you make and how much should you charge for it?

0

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8

0 8,000 16,000 24,000 32,000 40,000 48,000 56,000 64,000 72,000 80,000Quantity Q: pounds of Cheerios

Pric

e P:

dol

lars

per

pou

nd

Demand and WTP

Total costs (TC) Unit cost × quantity$2 × Q

Total revenue (TR) Price × quantityP × Q

Profit (TR − TC) P × Q − $2 × Q(P − $2) × Q

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0 8,000 16,000 24,000 32,000 40,000 48,000 56,000 64,000 72,000 80,000

Pric

e P:

dol

lars

per

pou

nd

Quantity Q: pounds of Cheerios

$60,000$34,000$23,000$10,000

$0

Isoprofit curves (P − $2) × Q

Profit maximization

Feasible Set0

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0 8,000 16,000 24,000 32,000 40,000 48,000 56,000 64,000 72,000 80,000

Pric

e, P

: dol

lars

per

pou

nd

Quantity, Q: pounds of Cheerios

$60,000$34,000$23,000$10,000$0Demand curveE

Popsicle Sticks, Inc.Sister company to XYZ Airlines, probably

SpecificationsSquares attached at all four corners using labels

Labels cannot be wider than sticks

Squares must be square when inspected

Labels must be cut with the scissors, not be torn

CostsTable rental: $1.00

Scissor rental: $0.50

Popsicle stick: $0.10

Label per corner: $0.05

Wage per active employee: $0.40

Round 1 1 worker allowedTable rental: $1.00




Wage per employee: $0.40

Round 2 2 workers allowedTable rental: $1.00





Round 3 Unlimited workers allowedTable rental: $1.00





Fixed costs

Variable costs

Average costs

Cost function shape

Costs and profitMaking stuff costs money and affects profits

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2400

2600

2800

3000

3200

3400

3600

3800

4000

30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80

Average cost

-2000

48000

98000

148000

198000

248000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

Total cost of production, C(Q)

F

0

Quantity of cars, Q

Aver

age

cost

of p

rodu

ctio

nTo

tal c

ost o

f pro

duct

ion,

C(

Q)350,000

Quantity of cars, Q

0

A

Q0= 20

4,000

A

Q0= 20

C0 = 80,000

AC at A= slope of OA= C0/Q0= 4,000

Q1= 40

B

B

Q1= 40

3,400

AC at B= slope of OB = 3,400

Q2= 60

D

D

Q2= 60

3,600

AC at D= slope of OD= 3,600

2000

2500

3000

3500

4000

4500

5000

5500

6000

3032343638404244464850525456586062646668707274767880

Average cost

-2000

48000

98000

148000

198000

248000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71

F

0 Q2= 60

D

Quantity of cars, Q

D

A

Tota

l cos

t of p

rodu

ctio

n,

C(Q)

350,000

Quantity of cars, Q

0 Q2= 60

4,600

A

Q0= 20

C0 = 80,000

1ΔC

A

ΔC= 2,200

1

ΔCD

ΔC= 4,600

AC

MC6,000

Aver

age

and

mar

gina

l cos

ts

of p

rodu

ctio

n

3,400

Q1= 40

B

Q1= 40

ΔC= 3,400

Q0= 20

2,200

2000

2200

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2600

2800

3000

3200

3400

3600

3800

4000

30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80

A

Q0= 20 Quantity of cars, Q

Aver

age

and

mar

gina

l cos

ts

of p

rodu

ctio

n

4,000

2,000

0

MC

B

Q1= 40

D

Q2= 60

AC

Size and locationEconomies of scale

Economies of agglomeration

Network effects

Cost to make stuff goes down as you make more stuff

Cost to make stuff goes down as you clump together

Cost to make stuff goes down when everyone uses your stuff

(Dis-)

Long-run vs short-run costs

LRAC

SRAC

Costs and scale

Economies of scale

Constant returns to scale

Diseconomies of scale

LRAC

SRAC

Next time…Profit maximization without isoprofit curves

Elasticities, taxes, market power

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