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A Further Note on the Cost Implications of Fluctuating Demand

Published online by Cambridge University Press:  19 October 2009

V. Kerry Smith  and
Joseph J. Seneca
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Extract

Presence of a variable market demand function for a given product has significant implications for factor input levels and for the resulting production costs to the firm. In a recent paper, McKean argues that in order to describe the costs of producing a product subject to fluctuating demand it is necessary to take into account the entire distribution of outputs as it relates to the static total cost function. While it is evident that influences on costs and factor inputs will differ in the case of a fluctuating demand schedule compared to the conventional stable demand conditions of classical micro theory, it is not clear that the use of a static cost function in conjunction with a probability distribution of outputs is the proper framework in which to examine the problem.

Type
Communications
Information
Journal of Financial and Quantitative Analysis , Volume 5 , Issue 3 , September 1970 , pp. 369 - 376
Copyright
Copyright © School of Business Administration, University of Washington 1970

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References

1 McKean, John R., “A Note on Administered Prices with Fluctuating Demand,” The Journal of Financial and Quantitative Analysis, March 1969, pp. 15–23.Google Scholar

2 Stigler, George, “Production and Distribution in the Short Run,” The Journal of Political Economy, June 1939, pp. 305–327.Google Scholar

3 McKean, “A Note on Administered Prices,” pp. 18–19.

4 Stigler, “Production and Distribution,” pp. 309–311.

5 Ibid., pp. 310–311.

6 Friedman, Milton, Price Theory (Chicago: Aldlne Publishing Co., 1962), p. 138Google Scholar. Also see Ozga, S. A., Expectations in Economic Theory (Chicago: Aldine Publishing Co.), 1965, pp. 131–136.Google Scholar

7 Note that for a static cost function, the derivation is the minimization of the following function: , so that the optimum combination of K and L to produce a given quantity is dictated by the familiar equality, where MPPL = marginal physical product of L, and MPPK = marginal physical product of K. Evaluating the function C in terms of the factor prices (assuming perfect competition in the factor markets) and the quantity of output, the static total cost function can be derived.

8 .Stigler, “Production and Distribution,” pp. 309–311.

9 For further discussion of this viewpoint, see: Chiang, Alpha C., Fundamental Methods of Mathematical Economies (New York: McGraw-Hill Book Company, 1967), pp. 253–261Google Scholar. It might then be suggested that Rn functions as an index of the degree of flexibility as well.

10 See footnote 8 for derivation of the conventional factor hiring rule. It should be noted that is the expected output

B1

over a range of the probability distribution of outputs. The size of this range is determined by the levels of flexibility in the factor inputs.

11 Note that and are all constants because they are values of the respective partial derivatives.

12 Stigler, , “Production and Distribution,” pp. 314–315.Google Scholar

13 .Ibid., pp.316–318.

14 McKean, “A Note on Administered Prices,” pp. 18–19.

15 Ibid., pp. 20–21.

16 For an example of a theoretical treatment of the effects of user costs, advertising, excess capacity, output variability, and the resulting intertemporal problems for the firm on its profit maximizing policies, see, Weintraub, S., Intermediate Price Theory (Philadelphia: Chilton Books, 1964), pp. 304–307; 353–359.Google Scholar