LECTURE 8 TITLE : The Economic of International Shipping Basic Economic Theory

1.0 OBJECTIVE. 1.1 To introduce some of the underlying knowledge in economic studies.

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INTRODUCTION 2.1 2.2 2.3 2.4 Shipping companies exist with the aim of making profit. It will operate along a line that will guaranty efficiency. It will be managed to maximise gain within the constraints. A liner company operate under conferences and liner ships sails although there is no cargo along the predetermined route. A bulk shipping company operates independently and its ships only sails when there is cargo to carry. Bulk shipping thus really operate on the basis of instantaneous demand and supply whereas liners are not. The following paragraphs will gives understanding on the basic theory in demand and supply prior to moving on to understanding the operational criteria demand and supply applicable to liner and bulk shipping.

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BASIC ECONIMIC TERMINOLOGY 3.1 The five basic terminology in economic studies are . 3.2 ..demand and supply,.. 3.3 ..the theory of cost,..

3.4 3.5 3.6

..the theory of revenue,.. ..the theory of production. A shipping company in full swing is actually economically operating at a point that balance all the four components above. 3.7 ..(refer to figure on MC, AC and MR),.. 3.8 MR is marginal revenue, MC is marginal cost, AC is average cost and P and Q are price and quantity respectively. 4.0 DEMAND AND SUPPLY. 4.1 Demand starts from utility. 4.2 In this context utility is the usefullness of a certain product. 4.3 The degree of usefullness of a product to a consumer follows the pattern that it first increases after the first unit until a point where he enjoy the most. 4.4 ..(refer to figure on utility line ),.. 4.5 It then falls as he is given more and more of it and finally become useless to him . 4.6 Demand is the rate of usefullness against quantity ( dU/dQ) and thus the gradient at points along the curve of utility. 4.7 We will thus have positive demand until a point when the curve makes a turn downwards. 4.8 A plot of dU/dQ against quantity is as follows: 4.9 ..(refer to figure on deman curve),.. 4.10 The company is of course using the demand curve derived when dU/dQ is above zero. 4.11 The highest dU/dQ is the highest price that he is willing to pay and thus it is normally designated as P axis. 5.0 SUPPLY

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Supply is actually a derived action of demand. Producer response to the demand curve and thus start producing unit one of the product at origin (0,0) when demand is the highest. ..(refer to figure on demand and supply ),. Supply will continue until there is no demand. On an axis of P against Q, the plot is a straight line from (0,0) with a positive gradient. The intersection point is the equilibrium point where supply meets the demand.

6.0 COST 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 6.9 6.10 6.11 6.12 6.13 6.14 Cost is of two components: ..fixed cost, and.. ..variable cost. ..(refer to plot on fixed and variable cost).. variable cost starts at (0,0) and increases as q increases tracing an s shaped curve. Fixed cost is incurred even at no production and thus it starts at a non zero value. Fixed cost however is constant and does not change with production level. Curve of total cost (TC) is obtained from the summation of both these costs The short term average total cost curve (SATC) is total cost divided by quantity (TC/Q) for every Q. Note this is not a plot of gradient along the TC curve. The short term average total cost curve is a U (or V) shaped curve on P against Q plot. ..(refer to figure on ATC curve),. Gradient at every Q on TC curve will give a plot of short term marginal cost (SMC). Marginal cost is the additional cost of producing next one unit of production.

6.15 The short term marginal cost is also a U shaped curve. 6.16 ..(refer to figure on SMC),.. 6.17 When the two curves are plot together SMC curve will cut SATC at minimum point of the later. 7.0 REVENUE 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 Revenue is calculated from total of sale. From the plot of demand curve on P against Q, revenue is thus PXQ. PXQ is also the area below the curve of D at that particular demand point. ..(refer to figure on PXQ),. MR is the additional revenue from selling the next unit of production. It is the revenue at Q now minus the revenue at Q one unit before. The plot of MR is as follows: ..(refer to MR plot),. The MR plot is a straight line below he demand curve, starting from where D starts on the P axis and end on the Q axis halfway between (0,0) and where D cut the Q axis.

8.0 CLOSING A shipping company will operate at a point where at least MR=MC. 8.2 A bulk shipping company operating close to perfect competition will operate within this point,. 8.3 ..so as the case for liner shipping company although the later is not operating in perfect competition market. 8.4 Understanding on demand and supply and cost and revenue is thus very important in understanding the economic of shipping services. 8.1