Department of Managerial Economics and Decision Sciences

HOMEWORK: COST CURVES, SUPPLY CURVES,

AND EQUILIBRIUM IN THE GLOBAL COPPER
MARKET1
In the world market for copper, there are two types of copper mines: Type 1 (primarily
located in North America) and Type 2 (primarily located in Asia and South America).
Each type of mine incurs five “buckets” of costs: (1) direct materials; (2) energy inputs
(such as electricity and natural gas); (3) shipping; (4) production labor; and (5)
production and administrative overhead.

Direct materials, energy inputs, and shipping services are purchased in competitive spot
markets, and the total monthly costs that a firm incurs on these items vary in direct linear
proportion to the quantity of copper produced in the mine during that month. If a mine
produces no copper in a particular month, it incurs no direct materials, energy, or
shipping costs.

By contrast, the total monthly costs for production labor and overhead are volume-
insensitive: the levels of these costs do not vary with the volume of production in the
mine. Even if the mine temporarily suspended operations for a month (i.e., produced zero
output in that month), the mine would still incur the same total monthly cost for labor and
overhead that it would have incurred had the mine produced a positive volume of copper.
Labor and overhead costs would “go away” only if the mine was permanently shut down
and withdrawn from the industry.

Each type of mine has a capacity that dictates the maximum amount of copper that can be
produced in a given month. The firm can produce any volume of output in the mine,
provided that it does not exceed this capacity.

The table below shows the cost profiles of the two different types of mines, as well as
their capacities (expressed as tons of copper per month). It also shows the number of
mines that are on active or near-active status in the world market as of January 2005. All
costs are expressed on an average cost basis (i.e., per ton of copper produced). The
average costs of labor and overhead indicate what the per-ton costs would be if a mine
produced at full capacity.

1
© Professor David Besanko, Kellogg School of Management. This exercise was prepared for use in class discussion
in MECN 430 Microeconomic Analysis. Do not copy this document for any other use without my explicit permission.
Version of August 19, 2004.
Mine Number Direct Energy Shipping Labor Overhead Capacity
of active Materials ($ per ($ per ($ per ton, ($ per ton, of a mine
or near- ($ per ton) ton) assuming assuming (tons per
active ton) full full month)
mines: capacity capacity
Jan. 2005 output)* output)*
Type 1 50 250 300 50 450 100 60,000
Type 2 40 150 200 100 150 100 100,000

The Deliverable
Please complete each of the following tasks. I would ask that you do this work using
pencil, paper, and (if needed) a calculator. Please do not use Excel. Using Excel may
save a little time, but it will obscure the basic logic that you need to follow in order to
drive toward a solution. You will learn more if you do this problem by hand.

While you do not need to show every step of arithmetic or algebra that you used to arrive
at your answers, please show enough of your work so that I can figure out the logic that
you used to arrive at your answer. Please keep your answer to three pages or less. You
may, if you like, use the graphs attached to this sheet to display your answers

Task 1: On the axes below (or using your own diagram) draw the marginal cost curve
(MC) and the average total cost (ATC) curve for a Type 1 mine. Your curves should be
as neat as possible, but they do not have to be absolutely, perfectly precise. You should,
however, clearly label each curve.

Task 2: On the axes below (or using your own diagram) draw the short-run industry
supply curve for the world copper market in January 2005. Please indicate how much
copper would be supplied in a given month if the price of copper were (a) $1,500 per ton;
(b) $1,000 per ton; (c) $500 per ton; and (d) $200 per ton.

Task 3: Suppose that the world demand curve for copper in January 2005 is expected to
be given by the formula D(P) = 7,700,000, – 1,000P, where D(P) denotes the quantity of
copper demanded (measured in tons per month) when the market price is P (measured in
dollars per ton). Given the supply curve you constructed, what would we expect to be the
market equilibrium price for copper in January 2005? How much copper will be bought
and sold at this equilibrium price? How much copper will be produced by all of the Type
1 mines together? How much copper will be produced by all of the Type 2 mines
together? (Drawing a careful picture of the demand and supply curves can be helpful; you
may want to use the axes below for this.)

Task 4: (Think of this part as “independent” from Task 3): Suppose that the market price
of copper is expected to be $1,000 per ton over the long run. Given this price expectation,
would the owners of Type 1 mines want to permanently shut down their mines and
withdraw them from the market? Would owners of Type 2 mines want to permanently
shut down their mines and withdraw them from the market? Briefly explain your answer.
For the purpose of this question, you may assume that a mine (other either type) has no
scrap value, and has no alternative use to which it could be redeployed if it is withdrawn
from the copper market.

2
 $5,000

$4,500

$4,000

$3,500
$ per ton

$3,000

$2,500

$2,000

$1,500

$1,000

$500

0
10,000 20,000 30,000 40,000 50,000 60,000

Q, tons of copper per month

Graph for MC and ATC curves for Type 1 Mine

3
 $2,500

$2,000
P, $ per ton

$1,500

$1,000

$500

0
0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000

Q, tons of copper per month

Graph for Short-run Market Supply Curve for Copper

4
 $2,500

$2,000
P, $ per ton

$1,500

$1,000

$500

0
0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000 7,000,000

Q, tons of copper per month

Graph to Display January 2005 Market Equilibrium