Ragan: Microeconomics

Seventeenth Canadian Edition

Chapter 8
Producers in the Long Run

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Chapter Outline/Learning Objectives
Section Learning Objectives
After studying this chapter, you will be able to
8.1 The Long Run: No Fixed 1. explain why profit maximization requires firms to
Factors equate marginal product per dollar spent for all
factors.
2. explain why profit-maximizing firms substitute away
from factors whose prices have risen and toward
factors whose prices have fallen.
3. understand the relationship between short-run and
long-run cost curves.
8.2 The Very Long Run: 4. discuss the importance of technological change and
Changes in Technology why firms are motivated to innovate.

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8.1 The Long Run: No Fixed Factors (1 of 2)

• In the short run, at least one factor is fixed.

• In the long run, all inputs are variable.
• In the long run, there are numerous ways to produce
any given output.
• In making its profit-maximizing choice, the firm tries to
be technically efficient.
• Technical efficiency occurs when a given number of
inputs are combined in such a way as to maximize the
level of output.

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8.1 The Long Run: No Fixed Factors (2 of 2)

• Technical efficiency is not enough for profits to be

maximized.
• To maximize profit, the firm chooses among the many
technically efficient options.
• The firm uses the technically efficient option that has
the lowest cost.
• To maximize profit, the firm chooses the lowest cost
combination of labour and capital.

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Profit Maximization and Cost
Minimization (1 of 4)
• Cost minimization is an implication of profit
maximization that firms choose the production method
that produces any given level of output at the lowest
possible cost.
• If it is possible to substitute one factor for another to
keep output constant while reducing total cost, the
firm is currently not minimizing its costs.

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Profit Maximization and Cost
Minimization (2 of 4)
• Using K to represent capital and L to represent labour,
and pL and pK to represent the prices per unit of the
two factors, the necessary condition for cost
minimization is:

MPK MPL MPK pK

= or =
pK pL MPL pL

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Profit Maximization and Cost
Minimization (3 of 4)
• Whenever the ratio of the marginal product of each
factor to its price is not equal for all factors, there are
possibilities for factor substitutions that will reduce
costs (for a given level of output).
• Profit-maximizing firms react to changes in factor
prices by changing their methods of production.

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Profit Maximization and Cost
Minimization (4 of 4)
• Methods of production change when the relative
prices of factors change.
• Relatively more of the cheaper factor and relatively
less of the more expensive factor will be used.
• The principle of substitution is the principle that
methods of production will change if relative prices of
inputs change, with relatively more of the cheaper
input and relatively less of the more expensive input
being used.

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Long-Run Cost Curves (1 of 2)
• When all factors of production can be varied, there
exists a least-cost method of producing any given
level of output.
• If this cost is expressed in terms of dollars per unit of
output, we obtain the long-run average cost of
producing each level of output.
• The long-run average cost (LRAC) curve is the
curve showing the lowest possible cost of producing
each level of output when all inputs can be varied.

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Long-Run Cost Curves (2 of 2)
• The LRAC is the boundary between cost levels that
are attainable, with known technology and given factor
prices, and those that are unattainable.
• Since all costs are variable in the long run, we do not
need to distinguish between AVC, AFC, and ATC, as
we did in the short run.
• In the long run, there is only one LRAC for any given
set of input prices.

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Figure 8-1 A “Saucer-Shaped” Long-Run
Average Cost Curve (1 of 8)
• Over the range of output from zero to QM long-run
average cost is falling. The firm is said to have
economies of scale.

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A “Saucer-Shaped” Long-Run Average
Cost Curve (2 of 8)
• Economies of scale is a reduction of long-run
average costs resulting from an expansion in the
scale of a firm’s operations so that more of all inputs is
being used.
• Over the range of output from zero to QM the firm is
enjoying increasing returns.
• Increasing returns is a situation in which output increases
more than in proportion to inputs as production increases.

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Figure 8-1 A “Saucer-Shaped” Long-Run
Average Cost Curve (3 of 8)
• At QM the firm is at its minimum efficient scale.

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A “Saucer-Shaped” Long-Run Average
Cost Curve (4 of 8)
• The minimum efficient scale is the smallest output
at which LRAC reaches its minimum.
• All available economies of scale have been realized at
this point.

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Figure 8-1 A “Saucer-Shaped” Long-Run
Average Cost Curve (5 of 8)
• At QM the firm experiences constant returns.

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A “Saucer-Shaped” Long-Run Average
Cost Curve (6 of 8)
• Constant returns is a situation in which the output
increases in proportion to inputs as production is
increased.

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Figure 8-1 A “Saucer-Shaped” Long-Run
Average Cost Curve (7 of 8)
• Over the range of output greater than QM the firm is
experiencing decreasing returns.

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A “Saucer-Shaped” Long-Run Average
Cost Curve (8 of 8)
• Decreasing returns is a situation in which output
increases less than in proportion to inputs as
production increases.
• Decreasing returns imply that the firm suffers some
diseconomies of scale.

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The Relationship Between the LRAC
and SRATC Curves
• The LRAC curve shows
the lowest cost of
producing any output
when all factors are
variable.
• SRATC curve shows the
lowest cost of producing Figure 8-2 LRAC and SRATC Curves

any output when one or

more factors are fixed.

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Figure 8-3 The Relationship Between the
LRAC Curve and the SRATC Curves (1 of 2)
• No short-run cost curve can fall below the long-run
cost curve because the LRAC curve represents the
lowest attainable cost for each possible output.

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Figure 8-3 The Relationship Between the
LRAC Curve and the SRATC Curves (2 of 2)
• Each SRATC curve is tangent to the LRAC curve at
the level of output for which the quantity of the fixed
factor is optimal and lies above it for all other levels of
output.

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Lessons from History 8-1
Jacob Viner and the Clever Draftsman
• Jacob Viner’s mistake was to require that the
draftsman connect all minimum points of the SRATC
curves rather than to construct the curve that would
be the lower envelope of all SRATC curves.
• The lower envelope curve is the LRAC curve and is
tangent to each SRATC curve.

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8.2 The Very Long Run: Changes in
Technology (1 of 2)
• In the long run, firms are producing on the LRAC
curves.
• In the very long run, there are changes in the
available techniques and resources.
• These changes cause shifts in the LRAC curve.

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8.2 The Very Long Run: Changes in
Technology (2 of 2)
• Technological change in any change in the available
techniques of production.
• To measure the extent of technological change,
economists use the notion of productivity.
• Productivity is the output produced per unit of some
input.
• Two widely used measures of productivity are output
per work and output per hour of work.

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Technological Change
• The inventing and innovating of new products and
processes is done by firms in search of profits.
• So we say that technological change is endogenous
to the economic system rather than something that
occurs for unknown reasons.
• There are three aspects of technological change:
1. New techniques
2. Improved inputs
3. New products

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Firms’ Choices in the Very Long Run
• Faced with increases in the price of an input, firms
may either substitute away or innovate away from the
input—or do both over different time horizons.
• Invention and innovation are subject to great
uncertainties that are difficult to estimate in advance.
• So they must produce large profits when they do
succeed to induce inventing firms to incur the costs of
pushing into the unknown.

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Applying Economic Concepts 8-1 (1 of 2)

The Significance of Productivity Growth

• The Significance of Productivity Growth
– “Dismal science”
– Predictions of Thomas Malthus
– Proven wrong for two reasons:
1. Populations did not expand as quickly as predicted
2. Technological advancements have increased output

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Applying Economic Concepts 8-1 (2 of 2)

The Significance of Productivity Growth

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