sayre | morris seventh edition costs in the long run chapter 7 7-1© 2012 mcgraw-hill ryerson...
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SAYRE | MORRIS Seventh Edition
Costs in the Long Run
CHAPTER 7
7-1© 2012 McGraw-Hill Ryerson Limited
Learning Objectives:
Costs in the Long Run
LO1: Distinguish between the short run and the long run
LO2: Understand why medium-sized firms are sometimes just as efficient as big firms
LO3: Understand why big firms sometimes enjoy great cost advantages
LO4: Understand why firms can sometimes be too big
CHAPTER 7
7-2© 2012 McGraw-Hill Ryerson Limited
Learning Objectives:
Costs in the Long Run
LO5: Understand the effect of technological change on a firm’s cost
LO6: Explain what is meant by the right size of firm
LO7: Explain why markets can sometimes be too small
CHAPTER 7
7-3© 2012 McGraw-Hill Ryerson Limited
The Long Run
Long Run • the period of time during which all inputs are
variable
• all production processes operate in the short run, and diminishing marginal productivity applies
• in the long run, all costs are variable and diminishing marginal productivity does not apply
• a firm can plan as if it is in the long run, but it always operates in the short run
7-4© 2012 McGraw-Hill Ryerson Limited
LO1
The Long Run
Long Run Average Cost Curve • a graphical representation of the per unit costs of
production in the long run
Constant Returns to Scale • the situation in which a firm’s output increases by
the same percentage as the increase in its inputs
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LO2
Average Costs of Production in Four Plant Sizes
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LO2
Self-Test
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The accompanying table shows the average costs associated with three different plant sizes: a) Which plant is best suited to produce an output of 4 units? b)What is the value of long-run average cost?
LO2
OutputPlant 1
Average CostPlant 2
Average CostPlant 3
Average Cost
1 $45 $62 $80
2 36 47 63
3 42 36 49
4 55 44 36
5 70 68 52
Self-Test
7-8© 2012 McGraw-Hill Ryerson Limited
The accompanying table shows the average costs associated with three different plant sizes: a)Which plant is best suited to produce an output of 4 units?
Plant 3 (It is the lowest average cost for that output.)
LO2
OutputPlant 1
Average CostPlant 2
Average CostPlant 3
Average Cost
1 $45 $62 $80
2 36 47 63
3 42 36 49
4 55 44 36
5 70 68 52
Self-Test
7-9© 2012 McGraw-Hill Ryerson Limited
The accompanying table shows the average costs associated with three different plant sizes: b)What is the value of long-run average cost?
$36 (It is the lowest average cost in all three plants.)
LO2
OutputPlant 1
Average CostPlant 2
Average CostPlant 3
Average Cost
1 $45 $62 $80
2 36 47 63
3 42 36 49
4 55 44 36
5 70 68 52
Economies of Scale
Economies of Scale • cost advantages achieved as a result of large-scale
operations
• firms in industries characterized by assembly-line production of standardized products tend to experience declining long-run average cost
• these industries are often dominated by a few large firms
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LO3
Economies of Scale
Reasons for Economies of Scale 1. big plants are able to exploit specialization of
labour on a far greater scale than small plants
2. large-scale production encourages management specialization
3. large scale production encourages machine specialization
4. big firms enjoy pecuniary economies of scale
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LO3
Economies of Scale
Pecuniary Economies of Scale • Lower cost of borrowing
• Buying in bulk
• Selling in bulk
• Economies of scale in marketing and advertising
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LO3
Economies of Scale
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LO3
Self-Test
7-14© 2012 McGraw-Hill Ryerson Limited
Indicate the presence of either constant returns to scale or increasing returns to scale in each set of data.
LO3
Total Cost Output
Set 1 $ 30 000 175
60 000 375
Set 2 450 000 100
900 000 200
Self-Test
7-15© 2012 McGraw-Hill Ryerson Limited
Indicate the presence of either constant returns to scale or increasing returns to scale in each set of data.
LO3
Total Cost Output
Set 1 $ 30 000 175
60 000 375
Set 2 450 000 100
900 000 200
Set 1: increasing returns to scale. (Average cost drops from $171.43 to $160.)
Set 2: constant returns to scale. (The average cost remains the same at $4500.)
Diseconomies of Scale
Diseconomies of Scale • bureaucratic inefficiencies in management that
result in decreasing returns to scale
Decreasing Returns to Scale • the situation in which a firm’s output increases by
a smaller percentage than its inputs
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LO3
LRAC Curve under Diseconomies of Scale
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LO2
Self-Test
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Decide in each of the following cases (A–D) whether constant returns, economies, or diseconomies of scale exist.
LO3
Inputs 1 Inputs 2 Output 1 Output 2
A 6 12 240 480
B 46 92 275 650
C 18 27 500 800
D 260 540 1240 2480
Self-Test
7-19© 2012 McGraw-Hill Ryerson Limited
Decide in each of the following cases (A–D) whether constant returns, economies, or diseconomies of scale exist.
LO3
A: constant returns to scale (Inputs 100%, output 100%.)B: economies of scale (Inputs 100%, output 136%.)
Inputs 1 Inputs 2 Output 1 Output 2
A 6 12 240 480
B 46 92 275 650
C 18 27 500 800
D 260 540 1240 2480
Self-Test
7-20© 2012 McGraw-Hill Ryerson Limited
Decide in each of the following cases (A–D) whether constant returns, economies, or diseconomies of scale exist.
LO3
C: economies of scale (Inputs 50%, output 60%.)D: diseconomies of scale (Inputs 108%, output 100%.)
Inputs 1 Inputs 2 Output 1 Output 2
A 6 12 240 480
B 46 92 275 650
C 18 27 500 800
D 260 540 1240 2480
Changes in Short Run and Long Run Costs
Technological Improvement • changes in production techniques that reduce the
costs of production
• causes a decrease in short-run costs
• since long-run average cost curve is derived from short-run cost curves, the long-run average costs also decrease
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LO5
The Right Size of Firm
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LO6
The Right Size of Firm
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LO6
Can a Market Be Too Small
Minimum Efficient Scale (MES) • the smallest sized plant capable of achieving the
lowest long-run average cost of production
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LO7
Can a Market Be Too Small
7-25© 2012 McGraw-Hill Ryerson Limited
LO7
© 2012 McGraw-Hill Ryerson Limited 7-26
• Firms always operate in the short run • Firms can plan as if they are in the long run where
all inputs are variable and diminishing marginal productivity does not apply
• Constant returns to scale exist when an increase in inputs result in a proportional increase in output
• Economies of scale involves either technical or pecuniary economies
Chapter 7 Summary
© 2012 McGraw-Hill Ryerson Limited 7-27
• Diseconomies of scale can occur due to inefficiencies
• costs can decrease due to a decrease in factor prices, technological improvement, or mergers reduce average fixed costs
• A firm is the right size if it captures economies of scale but does not suffer diseconomies
• A market is too small if it limits output to below economic capacity (SR) or below minimum efficient scale (LR)
Chapter 7 Summary