Economics 111.3 Winter 14
March 19th, 2014Lecture 24
Ch. 11: Long-run costsCh. 12: Perfect competition
• In the long run, the firm can vary both its use of labour and of capital.
• It will vary the use of both factors of production to maximize profits.
• As a result, long-run cost will always be less or equal to short-run cost.
Long Run Cost
© 2010 Pearson Education Canada
0 10 20 30 40 50 60 70 80 90
Figure 7-7
Output
Ave
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ATC-1 ATC-2ATC-3
ATC-4
ATC-5
Firm Size & Costs
0 10 20 30 40 50 60 70 80 90
Figure 7-7
Output
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rag
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ATC-1 ATC-2ATC-3
ATC-4
ATC-5
Firm Size & Costs
The Long-Run Average Cost Curve• The segments of the short-run
average total cost curves along which average total cost is the lowest make up the long-run average total cost curve.
• For every plant capacity size, there is a corresponding short-run ATC curve
• It shows the least ATC at which any output can be produced after the firm has had time to make all appropriate adjustments in its plant size.
• LRAC curve is the firms planning curve
Figure 7-8
Output
Ave
rag
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l Co
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the number of possible plant sizes is virtually unlimited
the number of possible plant sizes is virtually unlimited
The Long-run Cost Curve
Determinants of the Shape of the Long-Run Cost Curve: the existence of economies and diseconomies of scale
Economies of Scale• There are economies of scale in production when the long run
average cost decreases as output increases.• Economies of scale (increasing returns to scale) are cost
savings associated with larger scale of production.Economies of Scale are based on • labour specialization• managerial specialization• efficient capital• other factors, e.g., expected demand or “learning by doing”:
learning by doing means that as we do something, we learn what works and what doesn’t, and over time we become more proficient at it
Economies of Scale and Increasing Returns to Scale
• Increasing Returns to Scale occur whenever inputs do not need to be increased in proportion to the increase in output.
• Or when a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a larger percentage.
Constant Returns to Scale• Constant returns to
scale (CRTS) occur where long-run average total costs do not change as output increases.
• It is shown by the flat portion of the long run average total cost curve.
Diseconomies of Scale• Diseconomies of scale or decreasing returns to
scale refer to the increasing long run average costs as output increases. Diseconomies occur for a number of reasons as the firm increases its size– Coordination of a large firm is more difficult– Information costs and communication costs
increase as firm increases– Monitoring costs increase– Team spirit may decrease
Diseconomies of scale in terms of firm’s technology are called
Summary of Returns to Scale
Returns to scale Doubling inputs results in:
Slope of the LRAC
Increasing returns to scale (IRTS; economies of scale)
Output more than doubles.
downward
Constant returns to scale (CRTS)
Output exactly doubles. horizontal
Decreasing returns to scale (DRTS; diseconomies of scale)
Output less than doubles. upward
Minimum efficient scale of production
• A firm’s minimum efficient scale is the smallest quantity of output at which long-run average cost reaches its lowest level
• The minimum efficient scale of production will be at the beginning of the constant returns portion of the average cost curve—where average total costs are at a minimum.
Economies of Scale
• The implication of economies of scale is that in some industries firms must be of a certain size to be able to compete successfully.
Competitive industries
The firms in some industries minimize their average costs at a small plant size: apparel, food processing, furniture, wood products, snowboarding, and small-appliance industries are examples.
Minimum Efficient ScaleFigure 7- 9c
Output
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MESMES
LRATC
Oligopolistic industries
In oligopolistic industries, in order to take full advantage of economies of scale, firms must produce with very large facilities that allow the firms to spread costs over an extended range of output. Examples would be: automobiles, aluminium, steel, and other heavy industries. This pattern also is found in several new information technology industries.
Minimum Efficient ScaleFigure 7- 9b
Output
Ave
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LRATC
MESMES
• Min ATC
Quantity (millions of kilowatt-hours)
5
10
15
Natural Monopoly
0 1 2 3 4
DPri
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ATC
Natural MonopolyA natural monopoly is an industry in which
one firm can produce at a lower cost than can two or more firms.
Rationale: technology is such that minimum efficient scale is so large that average total costs fall within the range of potential output.