8 3longruncosts

Long Run Cost
Making Long-Run Production Decisions

To make their long-run decisions:
Firms look at costs of various inputs and the technologies available for combining these inputs. Then decide which combination offers the lowest cost.
Making Long-Run Production Decisions

The firm makes long-run decisions on the basis of the expected costs and expected usefulness of inputs.
Technical Efficiency and Economic Efficiency

Technical efficiency as few inputs as possible are used to produce a given output. Technical efficiency is efficiency that does not consider cost of inputs.
Technical Efficiency and Economic Efficiency

Economically efficient the method that produces a given level of output at the lowest possible cost. It is the least-cost technically efficient process.
Economies of Scale and Long-Run Cost Curves

In the long run, a firm has many sizes to choose from. The short run requires that scale be fixed only one or a few resources can be changed.
Determinants of the Shape of the Long-Run Cost Curve

The law of diminishing marginal productivity does not hold in the long run. All inputs are variable in the long run.
Determinants of the Shape of the Long-Run Cost Curve

The shape of the long-run cost curve is due to the existence of economies and diseconomies of scale.
Economics of Scale
Scale means size. Economies of scale: the decrease in per unit costs as the quantity of production increases and all resources are variable Diseconomies of scale: the increase in per unit costs as the quantity of production increases and all resources are variable Constant returns to scale: unit costs remain constant as the quantity of production is increased and all resources are variable
A Typical Long-Run Average Total Cost Table

Total Costs Quantity of Labor Total Cost Total Costs = Average Total of Machines TCL + TCM Costs = TC/Q
11 12 13 14 15 16 17 18 19 20
McGraw-Hill/Irwin
$381 390 402 420 450 480 510 549 600 666
$254 260 268 280 300 320 340 366 400 444
$635 650 670 700 750 800 850 915 1,000 1,110
$58 54 52 50 50 50 50 51 53 56
2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
A Typical Long-Run Average Total Cost Curve

$64 62 60 58 56 54 52 50 48
Costs per unit
Average total cost Minimum efficient level of production
11 12 13 14 15 16 17 18 19 20 Quantity
McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Economies of Scale
Economies of scale long run average total costs decrease as output increases. In real-world production processes, economies of scale are extremely important at low levels of production.
Economies of Scale
An indivisible setup cost is the cost of an indivisible input for which a certain minimum amount of production must be undertaken before the input becomes economically feasible to use.
Economies of Scale
Indivisible setup costs create many realworld economies of scale. The cost of a blast furnace or an oil refinery is an example of an indivisible setup cost.
Economies of Scale
In the longer run all inputs are variable, so only economies of scale can influence the shape of the long-run cost curve.
Economies of Scale
Because of the importance of economies of scale, business people often talk of a minimum efficient level of production.
Economies of Scale
The minimum efficient level of production is the amount of production that spreads setup costs out sufficiently for firms to undertake production profitably.
Economies of Scale
The minimum efficient level of production is reached once the size of the market expands to a size large enough so that firms can take advantage of all economies of scale.
Minimum Efficient Scale

Most industries experience both economies and diseconomies of scale. The minimum efficient scale (MES) is the minimum point of the long-run average-cost curve; the output level at which the cost per unit of output is the lowest.
The MES varies considerably across industries.
Diseconomies of Scale
Diminishing marginal productivity refers to the decline in productivity caused by increasing units of a variable input being added to a fixed input.
Diseconomies of scale refer to decreases in productivity which occur when there are equal increases of all inputs (no input is fixed).
Diseconomies of scale occur on the right side of the long-run average cost curve where it is upward sloping, meaning that average cost is increasing.
As the size of the firm increases, monitoring costs generally increase. Monitoring costs are those incurred by the organizer of production in seeing to it that the employees do what they are supposed to do.
As the size of the firm increases, team spirit or morale generally decreases. Team spirit is the feelings of friendship and being part of a team that brings out peoples best effort
Constant Returns to Scale

Constant returns to scale is where longrun average total costs do not change as output increases. It is shown by the flat portion of the LRATC curve.
Long-Run and Short-Run Cost Curves (1)
Economies and Diseconomies of Scale

$64 62 60 58 56 54 52 50 48 Economies of Scale Constant returns to Scale Diseconomies of Scale Average total cost
Costs per unit
11 12 13 14 15 16 17 18 19 20 Quantity
A Typical Long-Run Average Total Cost Curve Costs per unit

$60
Minimum efficient level of production
Long-run average total cost (LRATC)
$55
$50 11 14 17 20 ATC falls because ATC rises because ATC is constant of economies because of constant of diseconomies of scale of scale returns to scale
13-27
Importance of Economies and Diseconomies of Scale

Economies and diseconomies of scale play important roles in real-world long-run production decisions.

The long-run and the short-run average cost curves have the same U-shape, but the underlying causes of these shapes differ.

Economies and diseconomies of scale account for the shape of the long-run total cost curve.
The Envelope Relationship

Long-run costs are always less than or equal to short-run costs because: In the long run, all inputs are flexible In the short run, some inputs are fixed There is an envelope relationship between long-run and short-run average total costs. Each short-run cost curve touches the long-run cost curve at only one point.
In the short run all expansion must proceed by increasing only the variable input
This constraint increases cost
13-32
Costs per unit
The Envelope of Short-Run Average Total Cost Curves

LRATC
SRMC1 SRATC1 SRMC2 SRATC2 SRMC3 SRATC4 SRMC4 SRATC3
The long-run average total cost curve (LRATC) is an envelope of the short-run average total cost curves (SRATC1-4)
13-33
Short-Run and Long-Run Average-Cost Curves
Long-Run Average Total Cost

Long-run average total cost (LRATC): the lowest-cost combination of resources with which each level of output is produced when all resources are variable. The long-run average total cost curve gets its shape from economies and diseconomies of scale.
Shape of LRATC
If producing each unit of output becomes less costly there are economies of scale. If producing each unit of output becomes more costly there are diseconomies of scale. If unit costs remain constant as output rises there are constant returns to scale.

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Long Run Cost

Making Long-Run Production Decisions

Making Long-Run Production Decisions

Technical Efficiency and Economic Efficiency

Technical Efficiency and Economic Efficiency

Economies of Scale and Long-Run Cost Curves

Determinants of the Shape of the Long-Run Cost Curve

Determinants of the Shape of the Long-Run Cost Curve

A Typical Long-Run Average Total Cost Table

2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

A Typical Long-Run Average Total Cost Curve

Costs per unit

Average total cost Minimum efficient level of production

Minimum Efficient Scale

The MES varies considerably across industries.

Constant Returns to Scale

Long-Run and Short-Run Cost Curves (1)

Economies and Diseconomies of Scale

Costs per unit

A Typical Long-Run Average Total Cost Curve Costs per unit

Long-run average total cost (LRATC)

Long-Run and Short-Run Cost Curves (3)

Importance of Economies and Diseconomies of Scale

Importance of Economies and Diseconomies of Scale

Importance of Economies and Diseconomies of Scale

The Envelope Relationship

Costs per unit

The Envelope of Short-Run Average Total Cost Curves

Short-Run and Long-Run Average-Cost Curves

Long-Run Average Total Cost

Long-Run and Short-Run Cost Curves (2)

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