Rising firm production costs

Phil Ruder, Pacific University,
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Summary

Students read an article before class and then complete a guided worksheet on the technical model of competitive markets and firms. The AE asks student teams to make their own predictions about long-run events in the market. The exercise gives students practice manipulating the technical framework and also making the connection between the economic model and actual events in the economy.

Context for Use

This AE should come late in the sequence of applications for student learning related to event analysis in competitive firms and markets in a microeconomics principles course. The AE might come early in a similar unit in an intermediate microeconomics course, as student skills in this area are often rusty, even though they ought to have used the framework extensively in the prerequisite course.
Students should have completed the RAP for the unit. Principles students should also have completed a number of AEs emphasizing the building blocks of the model: definitions of terms and important concepts, including short- and long-run adjustments in competitive markets.
There are no class size limitations.
This activity will take between 40 and 60 minutes of class time, including individual and team work on guided templates, team choice of the best single answer, debriefing conversation, and concluding remarks.
This AE stands on its own, unconnected with other AEs in the library.

Overview

Before this in-class activity, students read a Wall Street Journal article that considers company costs that are rising faster than the prices of firm products before class and answer some Just-in-Time-Teaching (JiTT) questions in preparation before class. In the class, students first use a template to map the short-run events described in the article in the competitive market and firm side-by-side framework. Students also identify the long-run prediction of the model in their guided work before the AE. The AE asks student teams to make their own predictions about long-run events in the market. The exercise gives students practice manipulating the technical framework and also making the connection between the economic model and actual events in the economy.

Expected Student Learning Outcomes

Upon successful completion of this learning activity, students will be able to
*analyze the short- and long-run effects of cost events in competitive markets using the side-by-side model of competitive firms and markets.
*describe the experience of an actual firm in an industry experiencing cost increases.
*predict the long-run outcome of a cost increase for the firm and industry

Information Given to Students

Consider the events described in the article "Company Costs are Rising, But Getting Shoppers to Pay More is Hard" (WSJ, May 9, 2018). What will happen to the market price in the perfectly competitive corn starch industry in the long run, assuming no other events occur?
Complete the worksheet and then select one of the following possible answers.
A. 100% of the cost increase will be borne by producers.
B. 100% of the cost increase will be borne by consumers.
C. The proportion of the cost increase passed on to consumers depends on the price elasticities of supply and demand.
D. Inventors will discover alternatives to corn starch and this product will disappear from use in the United States.


Student worksheet on production cost increase (Microsoft Word 2007 (.docx) 6.7MB Jun24 19)
JiTT questions for rising firm production costs (Microsoft Word 2007 (.docx) 14kB Jun24 19)


Teaching Notes and Tips

I used a local (Forest Grove, Oregon) firm for this exercise. It is pretty easy to find a local firm for this problem. Any firm that ships output via truck will share the experience described in the news article.
The link to the WSJ news article is below. At the time of this writing, the article is available to the public rather than behind a paywall with most WSJ content. If that changes, it will be necessary to find a similar article or podcast on which to base student preparation.
In advance of this exercise, I recommend reviewing the competitive model side-by-side market and firm framework. My students have fits with this model, even at the intermediate level. I present this model after the wRAP-up for this module of the course and right before this AE, I'll walk them through an example of a demand event, leaving that analysis up on the board as a hint for the technical analysis in the worksheet. I will have to provide an additional hint to most teams that if the event under analysis is a change in firm fixed or variable cost, the analysis has to start in the firm, not the market, side of the framework.
Even when students get the technical analysis correct -- plenty don't in my classes! -- the AE can still generate a distribution of student responses across the possible answers. Notice that B and D are possible, with B being more likely.
In the debriefing process, I usually call for some team reporters to come to the doc cam at the front of the classroom to explain their analysis in the worksheet. This can be difficult for many students and is good practice for them. This might be a good time to remind students that learning is a struggle, not a series of easy "aha!" moments.
I ask student reporters when B would be the likely outcome and when D would be, assuming the market in question is perfectly competitive. The answer has to do with whether close substitutes for the good exist or are likely to be discovered.
In the suggested JiTT questions, I ask students to think about when the predictions of the competitive model are likely to hold and when they are not. In the debriefing process, I mention that the assumptions of the competitive model are pretty strong and that firms might not actually pass on the full cost increase to consumers. I ask student reporters to identify situations in which firms might not pass all of the cost increase along. If profit margins are high, those might be reduced. If there is some process inefficiency, firms might be able to reduce other costs rather than increase prices by the full amount of the freight cost increase. This is a good way to foreshadow the consideration of imperfect competition, which is generally the next module of the course. A student reporter might identify freight alternatives to shipping by truck. Good thinking. If a firm can switch some of its shipping to rail or boat, the long-run price increase might also be smaller than the increase in trucking costs emphasized in the news article.
One could ask student reporters how their analysis would be different if fixed, rather than variable, costs rose.
In closing remarks, I remind students that they should be ready to analyze six possible types of events with the framework: demand increase, demand decrease, variable cost increase, variable cost decrease, fixed cost increase, fixed cost decrease.
This is inevitably a more technical, less conceptual AE in a relatively technical module of the micro principles course.

Assessment

Assume that New Season Foods is a firm that sells its product in a perfectly competitive market. Suppose that the invention of driverless trucks greatly reduces New Season Foods' shipping cost.
A. Analyze the short- and long-run effects of this event for New Season Foods and the corn starch market using the competitive model side-by-side framework. Explain each step of your graphical analysis in words.
B. Under what circumstances might the cost reduction NOT be passed on fully to consumers even in the long run?

References and Resources

The link to the WSJ article "Company Costs Are Rising, but Getting Shoppers to Pay More is Hard" (Wall Street Journal, May 9, 2018) is https://www.wsj.com/articles/company-costs-are-rising-but-getting-shoppers-to-pay-more-is-hard-1525898957