Production And Cost in the Long Run

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Production And Cost in the Long Run

• In the long run, costs behave differently
• Firm can adjust all of its inputs in any way it
  wants
• In the long run, there are no ___ inputs or ___
  costs
• All inputs and all costs are ______
• Firm must decide what combination of inputs to
  use in producing any level of output
• The firms goal is to ___________
• To do this, it must follow ______________
• To produce any given level of output the firm
  will choose the input mix with the lowest cost

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Different ways to wash 196 cars per day
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Production And Cost in the Long Run

• Long-run total cost
• The cost of producing each quantity of output
  when the least-cost input mix is chosen in the
  long run
• Long-run average total cost
• The cost per unit of output in the long run, when
  all inputs are variable
• The long-run average total cost (LRATC)
• Cost per unit of output in the long-run

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Long-Run and Short-Run Costs for Spotless Car Wash
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The Relationship Between Long-Run And Short-Run
Costs

• For some output levels, LRTC is ______ than TC
• Long-run total cost of producing a given level of
  output can be less than or equal to, but never
  greater than, short-run total cost (LRTC TC)
• Long-run average cost of producing a given level
  of output can be less than or equal to, but never
  greater than, shortrun average total cost (LRATC
  ATC)

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Average Cost And Plant Size

• Plant
• Collection of fixed inputs at a firms disposal
• Can distinguish between the long run and the
  short run
• In the long run, the firm can change the size of
  its plant
• In the short run, it is stuck with its current
  plant size
• ATC curve tells us how average cost behaves in
  the short run, when the firm uses a plant of a
  given size
• To produce any level of output, it will always
  choose that ATC curveamong all of the ATC curves
  availablethat enables it to produce at lowest
  possible average total cost
• This insight tells us how we can graph the firms
  LRATC curve

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Figure 7 Long-Run Average Total Cost
ATC1
LRATC
ATC3
ATC0
ATC2
C
D
B
E
A
175
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Graphing the LRATC Curve

• A firms LRATC curve combines portions of each
  ATC curve available to firm in the long run
• For each output level, firm will always choose to
  operate on the ATC curve with ________________
• In the short run, a firm can only move along its
  current ATC curve
• However, in the long run it can move from one ATC
  curve to another by varying the size of its plant
• Will also be moving along its LRATC curve

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Economics of Scale

• Economics of scale
• Long-run average total cost _____ as output
  increases
• When an increase in output causes LRATC to
  decrease, we say that the firm is enjoying
  economics of scale
• The more output produced, the lower the cost per
  unit
• When long-run total cost rises proportionately
  less than output, production is characterized by
  economies of scale
• LRATC curve slopes ________

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Figure 8 The Shape Of LRATC
LRATC
0
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
Units of Output
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Gains From Specialization

• One reason for economies of scale is gains from
  specialization
• The greatest opportunities for increased
  specialization occur when a firm is producing at
  a relatively low level of output
• With a relatively small plant and small workforce
• Thus, economies of scale are more likely to occur
  at lower levels of output

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More Efficient Use of Lumpy Inputs

• Another explanation for economies of scale
  involves the lumpy nature of many types of
  plant and equipment
• Some types of inputs cannot be increased in tiny
  increments, but rather must be increased in large
  jumps
• Plant and equipment must be purchased in large
  lumps
• Low cost per unit is achieved only at high levels
  of output
• Making more efficient use of lumpy inputs will
  have more impact on LRATC at low levels of output
  
• When these inputs make up a greater proportion of
  the firms total costs
• At high levels of output, the impact is smaller

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Diseconomies of Scale

• Long-run average total cost _______ as output
  increases
• As output continues to increase, most firms will
  reach a point where bigness begins to cause
  problems
• True even in the long run, when the firm is free
  to increase its plant size as well as its
  workforce
• When long-run total cost rises more than in
  proportion to output, there are diseconomies of
  scale
• LRATC curve slopes ________________
• While economies of scale are more likely at low
  levels of output
• Diseconomies of scale are more likely at higher
  output levels

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Constant Returns To Scale

• Long-run average total cost is ______ as output
  increases
• When both output and long-run total cost rise by
  the same proportion, production is characterized
  by constant returns to scale
• LRATC curve is ___
• In sum, when we look at the behavior of LRATC, we
  often expect a pattern like the following
• Economies of scale (decreasing LRATC) at
  relatively low levels of output
• Constant returns to scale (constant LRATC) at
  some intermediate levels of output
• Diseconomies of scale (increasing LRATC) at
  relatively high levels of output
• This is why LRATC curves are typically U-shaped

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Using the Theory Long Run Costs, Market
Structure and Mergers

• The number of firms in a market is an important
  aspect of market structurea general term for the
  environment in which trading takes place
• What accounts for these differences in the number
  of sellers in the market?
• Shape of the LRATC curve plays an important role
  in the answer

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LRATC and the Size of Firms

• The output level at which the LRATC first hits
  bottom is known as the minimum efficient scale
  (MES) for the firm
• Lowest level of output at which it can achieve
  minimum cost per unit
• Can also determine the maximum possible total
  quantity demanded by using market demand curve
• Applying these two curvesthe LRATC for the
  typical firm, and the demand curve for the entire
  marketto market structure
• When the MES is small relative to the maximum
  potential market
• Firms that are relatively small will have a cost
  advantage over relatively large firms
• Market should be populated by many small firms,
  each producing for only a tiny share of the
  market

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LRATC and the Size of Firms

• There are significant economies of scale that
  continue as output increases
• Even to the point where a typical firm is
  supplying the maximum possible quantity demanded
• This market will gravitate naturally toward
  monopoly
• In some cases the MES occurs at 25 of the
  maximum potential market
• In this type of market, expect to see a few large
  competitors
• There are significant lumpy inputs that create
  economies of scale
• Until each firm has expanded to produce for a
  large share of the market

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Figure 9 How LRATC Helps Explain Market
Structure
LRATCTypical Firm
F
E
DMarket
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Figure 9 How LRATC Helps Explain Market
Structure
LRATCTypical Firm
DMarket
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Figure 9 How LRATC Helps Explain Market
Structure
LRATCTypical Firm
H
F
E
DMarket
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Figure 9 How LRATC Helps Explain Market
Structure
LRATCTypical Firm
E
F
DMarket
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LRATC and the Size of Firms

• The MES of the typical firm in this market is
  1,000 units
• Lowest output level at which it reaches minimum
  cost per unit
• For firms in this market, diseconomies of scale
  dont set in until output exceeds 10,000 units
• Since both small and large firms can have equally
  low average costs with neither having any
  advantage over the other
• Firms of varying sizes can coexist

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The Urge To Merge

• If by doubling their output, firms could slide
  down the LRATC curve in Figure 9, and enjoy a
  significant cost advantage over any other,
  still-smaller firm, they would
• This is a market that is ripe for a merger wave
• A sudden merger wave is usually set off by some
  change in the market
• Market structure in generaland mergers and
  acquisitions in particularraise many important
  issues for public policy
• Low-cost production can benefit consumersif it
  results in lower prices