Theory of cost cn f long run

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Theory of cost cn f long run

  1. 1. RET PA HC 8 Costs and Output Decisions in the Long Run Prepared by: Fernando Quijano and Yvonn Quijano© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  2. 2. The Concept of Profit • Profit is the difference between total revenue and total cost. • The economic concept of profit takes into account the opportunity cost of capital. • Total economic cost includes a normal rate of return. A normal rate of return is the rate that is just sufficient to keep current investors interested in the industry. • Breaking even is a situation in which a firm is earning exactly a normal rate of return.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  3. 3. The Long-Run Average Cost Curve • The long-run average cost curve (LRAC) is a graph that shows the different scales on which a firm can choose to operate in the long-run. Each scale of operation defines a different short-run.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  4. 4. The Long-Run Average Cost Curve • The long run average cost curve of a firm exhibiting economies of scale is downward- sloping.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  5. 5. Weekly Costs Showing Economies of Scale in Egg Production JONES FARM TOTAL WEEKLY COSTS 15 hours of labor (implicit value $8 per hour) $120 Feed, other variable costs 25 Transport costs 15 Land and capital costs attributable to egg production 17 $177 Total output 2,400 eggs Average cost $.074 per egg CHICKEN LITTLE EGG FARMS INC. TOTAL WEEKLY COSTS Labor $ 5,128 Feed, other variable costs 4,115 Transport costs 2,431 Land and capital costs 19,230 $30,904 Total output 1,600,000 eggs Average cost $.019 per egg© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  6. 6. A Firm Exhibiting Economies and Diseconomies of Scale • The long-run average cost curve of a firm that eventually exhibits diseconomies of scale becomes upward-sloping.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  7. 7. Optimal Scale of Plant • The optimal scale of plant is the scale that minimizes average cost.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  8. 8. Internal Versus External Economies of Scale • Economies of scale that are found within the individual firm are called internal economies of scale. • External economies of scale describe economies or diseconomies of scale on an industry-wide basis.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  9. 9. Long-Run Costs: Economies and Diseconomies of Scale • Increasing returns to scale, or economies of scale, refers to an increase in a firm’s scale of production, which leads to lower average costs per unit produced.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  10. 10. Long-Run Costs: Economies and Diseconomies of Scale • Constant returns to scale refers to an increase in a firm’s scale of production, which has no effect on average costs per unit produced.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
  11. 11. Long-Run Costs: Economies and Diseconomies of Scale • Decreasing returns to scale refers to an increase in a firm’s scale of production, which leads to higher average costs per unit produced.© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

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