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LONG-RUN
AVERAGE COST
   CHAPTER 22
LONG-RUN COSTS

•   Remember: All costs in the long run
    are variable!
•   The behavior of long-run cost
    depends on the firm’s production
    function which is the relationship
    between the maximum output
    attainable and the quantities of both
    labor and capital.
DIMINISHING RETURNS


  Diminishing returns occur at
  all the quantities of capital as
  the     quantity    of     labor
  increases.      The marginal
  product of labor eventually
  diminishes.
DIMINISHING PRODUCT
     OF CAPITAL
  The marginal product of
  capital is the change in total
  output divided by the change
  in capital when the quantity
  of labor is constant (the
  change in output that results
  from a one unit increase in
  the quantity of capital)
TWO IMPORTANT THINGS:


1.   Each short-run ATC curve is
     U-shaped.
2.   For each short run ATC
     curve, the larger the plant,
     the greater is the output at
     which average total cost is a
     minimum.
LONG-RUN AVERAGE
   COST CURVE
The long-run average
total cost curve is the
relationship between the
lowest attainable average
total cost and output
when both the plant size
and labor are varied.
LONG-RUN AVERAGE
       COST CURVE
•   The long-run ATC curve is a
    planning curve.
•   It tells the firm the plant size and
    the quantity of labor to use at
    each output to minimize cost.
•   Once       the     plant   size    is
    chosen, the firm operates on the
    short-run curves that apply to
    that plant size.
LONG-RUN AVERAGE
       COST CURVE
•   The long-run ATC curve is a
    planning curve.
•   It tells the firm the plant size and
    the quantity of labor to use at
    each output to minimize cost.
•   Once       the     plant   size    is
    chosen, the firm operates on the
    short-run curves that apply to
    that plant size.
ECONOMIES OF SCALE
 Economies of Scale result
 from features of a firm’s
 technology that lead to
 falling long-run average cost
 as output increases. The
 main source of economies of
 scales         is     greater
 specialization of both labor
 and capital.
ECONOMIES OF SCALE
 With        given     input
 prices, economies of scale
 occur if the percentage
 increase in output exceeds
 the percentage increase in
 all inputs.
DISECONOMIES OF SCALE
  Diseconomies of Scale lead to
  rising long-run average cost as
  output increases. The main source
  of diseconomies of scale is the
  difficulty of managing a very large
  enterprise. The larger the firm, the
  greater the challenge of organizing it
  and the communicating both up and
  down the management levels and
  among managers.           Eventually,
  management complexity brings rising
  average cost.
CONSTANT RETURNS TO
      SCALE
 Constant returns to scale are
 features of a firm’s technology that
 lead to constant long-run average
 cost as output increases.

 When constant returns to scale are
 present, LRAC curve is horizontal.
MINIMUM EFFICIENT
      SCALE
Minimum efficient scale is the
smallest quantity of output at which
long-run average cost reaches its
lowest level.
A firm experiences economies of
scale up to some output level.
Beyond that level, it moves into
constant returns to scale or to
diseconomies of scale.
The MES plays a role in determining
market structure, as you will soon
learn in the next three chapters…
EXAMPLE

We’ll do exercise 10 from
your worksheet here in
class together, in your
notebook, and determine
both     graphically  and
algebraically, where Cathy
encounters economies of
scale!

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Long run average total costs Chapter 22

  • 2. LONG-RUN COSTS • Remember: All costs in the long run are variable! • The behavior of long-run cost depends on the firm’s production function which is the relationship between the maximum output attainable and the quantities of both labor and capital.
  • 3. DIMINISHING RETURNS Diminishing returns occur at all the quantities of capital as the quantity of labor increases. The marginal product of labor eventually diminishes.
  • 4. DIMINISHING PRODUCT OF CAPITAL The marginal product of capital is the change in total output divided by the change in capital when the quantity of labor is constant (the change in output that results from a one unit increase in the quantity of capital)
  • 5. TWO IMPORTANT THINGS: 1. Each short-run ATC curve is U-shaped. 2. For each short run ATC curve, the larger the plant, the greater is the output at which average total cost is a minimum.
  • 6. LONG-RUN AVERAGE COST CURVE The long-run average total cost curve is the relationship between the lowest attainable average total cost and output when both the plant size and labor are varied.
  • 7. LONG-RUN AVERAGE COST CURVE • The long-run ATC curve is a planning curve. • It tells the firm the plant size and the quantity of labor to use at each output to minimize cost. • Once the plant size is chosen, the firm operates on the short-run curves that apply to that plant size.
  • 8. LONG-RUN AVERAGE COST CURVE • The long-run ATC curve is a planning curve. • It tells the firm the plant size and the quantity of labor to use at each output to minimize cost. • Once the plant size is chosen, the firm operates on the short-run curves that apply to that plant size.
  • 9. ECONOMIES OF SCALE Economies of Scale result from features of a firm’s technology that lead to falling long-run average cost as output increases. The main source of economies of scales is greater specialization of both labor and capital.
  • 10. ECONOMIES OF SCALE With given input prices, economies of scale occur if the percentage increase in output exceeds the percentage increase in all inputs.
  • 11. DISECONOMIES OF SCALE Diseconomies of Scale lead to rising long-run average cost as output increases. The main source of diseconomies of scale is the difficulty of managing a very large enterprise. The larger the firm, the greater the challenge of organizing it and the communicating both up and down the management levels and among managers. Eventually, management complexity brings rising average cost.
  • 12. CONSTANT RETURNS TO SCALE Constant returns to scale are features of a firm’s technology that lead to constant long-run average cost as output increases. When constant returns to scale are present, LRAC curve is horizontal.
  • 13. MINIMUM EFFICIENT SCALE Minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level. A firm experiences economies of scale up to some output level. Beyond that level, it moves into constant returns to scale or to diseconomies of scale. The MES plays a role in determining market structure, as you will soon learn in the next three chapters…
  • 14. EXAMPLE We’ll do exercise 10 from your worksheet here in class together, in your notebook, and determine both graphically and algebraically, where Cathy encounters economies of scale!