Long costs SFLS

1. Production and Costs
Long run costs

2. Short Run
Long Run
- Input quantity is fixed for a period of time
and cannot be varied. ( include sunk costs)
Types of Costs Through Time
Ex. You can’t change technology and
capital that quickly.
1.) Fixed costs
K – capital
2.) Variable costs
L - labor
- Input whose quantity the firm can
vary at any time.
Ex. Labor can change, you can fire or
hire workers.
- All inputs can be varied.
- What matters is the scale
1.) Everything is
variable!

3. The Production Function
Production Function - Amount of outputs that
can be produced with a
given set of inputsa.) Short run production
b.) Long run production
c.) Short run costs
d.) Long run costs

4. Long Run Costs
When a firm changes its plant size, its cost of
producing a given output changes.
Will the (ATC) average total cost of producing
something fall, rise, or remain the same?
Each of these three outcomes arise because when
a firm changes its size, it might experience:
Economies of scale
Constant returns to scale
Diseconomies of scale

5. For an example: IFor an example: I
often fly fromoften fly from
ShanghaiShanghai

6. To Los AngelesTo Los Angeles

7. And I have to crossAnd I have to cross
this ocean to get there,this ocean to get there,
so I take a planeso I take a plane
There is a direct flight fromThere is a direct flight from
Shanghai to LA everyday withShanghai to LA everyday with
about 500 people on average thatabout 500 people on average that
travel everyday from the twotravel everyday from the two
citiescities

8. It’s easier and cheaper forIt’s easier and cheaper for
everyone to go in one big planeeveryone to go in one big plane

9. Instead of like 50 small planesInstead of like 50 small planes

10. Apple makes products in ChinaApple makes products in China
for two big reasons…for two big reasons…

11. 1.) Because labor costs are cheap1.) Because labor costs are cheap

12. Guangzhou and Shenzhen areGuangzhou and Shenzhen are
basically city sized factories.basically city sized factories.
2.) Because the scale of2.) Because the scale of
production is so much higherproduction is so much higher
then anywhere else.then anywhere else.

13. Some factoriesSome factories
are the size ofare the size of
cities with all thecities with all the
stuff a city has.stuff a city has.

14. Economies of
scale
- when a firm increases its
inputs and its output
increases by a larger
percentage and average total
cost decreases.
- The main source of economies
of scale is greater
specialization of both labor
and capital.
Inputs by same % TP
By larger %
ATC
Long Run Costs

15. Fixed
costs
Variable
costs
For example: You haveFor example: You have
this factorythis factory

16. Fixed
costs
Variable
costs
Total
product
And this factory makesAnd this factory makes
some number ofsome number of
outputoutput

17. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!
Then you decide toThen you decide to
double your factorydouble your factory
and labor sizeand labor size

18. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!

19. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!

20. Bigger! More! We are in
the long run bitches!
Input
same %
Input
same %
Output
higher %
Output increase moreOutput increase more
then then inputs, youthen then inputs, you
have economies ofhave economies of
scalescale

21. Constant Returns
to scale
- when a firm increases its
inputs and its output
increases by the same
percentage and average total
cost remains constant.
Inputs by same % TP
By same %
ATCsame
Long Run Costs

22. Fixed
costs
Variable
costs
Total
product
Same example:Same example:

23. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!
Double the size of yourDouble the size of your
factory and labor…factory and labor…

24. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!

25. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!

26. Bigger! More! We are in
the long run bitches!
Input
same %
Input
same %
Output
same %
You get the same outputYou get the same output
amount then you haveamount then you have
constant returns to scaleconstant returns to scale

27. Diseconomies of
scale
-when a firm increases its
inputs and its output increases
by a smaller percentage and
average total cost increases.
- Diseconomies of scale arise
from the difficulty of
coordinating and controlling a
large enterprise.
Inputs by same % TP
By smaller %
ATC
Long Run Costs

28. Fixed
costs
Variable
costs
Total
product
One more time…One more time…

29. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!
Double your factory andDouble your factory and
labor size…labor size…

30. Fixed
costs
Variable
costs
Total
product
Bigger! More! We are in
the long run bitches!

31. Bigger! More! We are in
the long run bitches!
Input
same %
Input
same %
Output
lower
You get less output thenYou get less output then
your inputs your havingyour inputs your having
diseconomies of scale:diseconomies of scale:

33. Let’s say the amount of people that flyLet’s say the amount of people that fly
from PVG to LAX is 1200 and eachfrom PVG to LAX is 1200 and each
plane holds 500 people, that thirdplane holds 500 people, that third
plane with cost you more then youplane with cost you more then you
can profit from it and more planes iscan profit from it and more planes is
just more expensivejust more expensive

34. GMC (Genera Motors of theGMC (Genera Motors of the
United States) was the largest carUnited States) was the largest car
maker in the worldmaker in the world

35. In 2008 the market went way downIn 2008 the market went way down
and the demand for cars decreasedand the demand for cars decreased
a lota lot

36. GMC was a huge company for aGMC was a huge company for a
huge market, but was now too bighuge market, but was now too big
for the market at the time andfor the market at the time and
suffered diseconomies of scalesuffered diseconomies of scale

38. In the long run, Both capital and labor inputs can vary.
With current
firm,
ATC = ATC1.
With
successively
larger firms,
ATC curves
would be ATC2,
ATC3, and ATC4.

39. The long-run
average cost
curve, LRAC,
traces the lowest
attainable
average total
cost of
producing each
output.
In the long run, Both capital and labor inputs can vary.

40. Economies of scale as output increases to 9 gallons an
hour
constant returns
to scale for
outputs between
9 gallons and 12
gallons an hour.
and diseconomies
of scale for
outputs that
exceed 12 gallons
an hour.

41. How ATC Changes as
the Scale of Production Changes
Economies of scale:
ATC falls
as Q increases.
LRATC
Q
ATC

42. How ATC Changes as
the Scale of Production Changes
Economies of scale:
ATC falls
as Q increases.
Constant returns to
scale: ATC stays the
same
as Q increases.
LRATC
Q
ATC

43. How ATC Changes as
the Scale of Production Changes
Economies of scale:
ATC falls
as Q increases.
Constant returns to
scale: ATC stays the
same
as Q increases.
Diseconomies of
scale: ATC rises
as Q increases.
LRATC
Q
ATC

44. LRATC with 3 Firm Sizes
ATCS
ATCM
ATCL
Q
ATC
Firm can choose
from 3 factory
sizes: S, M, L.
Each size has its
own SRATC curve.
The firm can
change to a
different factory
size in the long
run, but not in the
short run.

45. Q
ATC
To produce less than QA,
firm will choose size S
in the long run.
LRATC with 3 Firm Sizes
ATCS
ATCM
ATCL
QA
Q
ATC

46. Q
ATC
To produce less than QA,
firm will choose size S
in the long run.
To produce between QA
and QB, firm will choose
size M
in the long run.
LRATC with 3 Firm Sizes
ATCS
ATCM
ATCL
QA QB
Q
ATC

47. Q
ATC
To produce less than QA,
firm will choose size S
in the long run.
To produce between QA
and QB, firm will choose
size M
in the long run.
To produce more than
QB, firm will choose size
L in the long run.
LRATC with 3 Firm Sizes
ATCS
ATCM
ATCL
QA QB
Q
ATC

48. Q
ATC
In the real world,
factories come in
many sizes,
each with its own
SRATC curve.
A Typical LRATC Curve

49. Q
ATC
In the real world,
factories come in
many sizes,
each with its own
SRATC curve.
So a typical
LRATC curve
looks like this:
LRATC
A Typical LRATC Curve

50. How ATC Changes as
the Scale of Production Changes
Economies of scale:
ATC falls
as Q increases.
Constant returns to
scale: ATC stays the
same
as Q increases.
Diseconomies of
scale: ATC rises
as Q increases.
LRATC
Q
ATC

51. That’s the basic idea forThat’s the basic idea for
now.now.
Bye bye.Bye bye.
Thank youThank you