Long run average total costs Chapter 22

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Long run average total costs Chapter 22

  1. 1. LONG-RUNAVERAGE COST CHAPTER 22
  2. 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. 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. 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. 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. 6. LONG-RUN AVERAGE COST CURVEThe long-run averagetotal cost curve is therelationship between thelowest attainable averagetotal cost and outputwhen both the plant sizeand labor are varied.
  7. 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. 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. 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. 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. 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. 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. 13. MINIMUM EFFICIENT SCALEMinimum efficient scale is thesmallest quantity of output at whichlong-run average cost reaches itslowest level.A firm experiences economies ofscale up to some output level.Beyond that level, it moves intoconstant returns to scale or todiseconomies of scale.The MES plays a role in determiningmarket structure, as you will soonlearn in the next three chapters…
  14. 14. EXAMPLEWe’ll do exercise 10 fromyour worksheet here inclass together, in yournotebook, and determineboth graphically andalgebraically, where Cathyencounters economies ofscale!

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