LongRun Directions

1
Long-Run Directions

• The Long-Run Average Cost Curve
• LRATC

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Profits, Losses, and Perfectly Competitive Firm
Decisions in the LR and SR

• In the short-run, firms have to decide how much
  to produce in the current scale of its plant.
• In the long-run, firms have to choose among many
  potential scales of plants.

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The LRATC and Returns to Scale

• A firms ability to expand or contract in the
  long-run depends upon the shape of its LRATC.
• The shape of the LRATC depends upon the Firms
  Returns to Scale.
• Returns to Scale is the relationship between a
  change in all inputs and output. Normally we
  examine this using ATC curves.

4
SRATC and LRATC

• The shape of the SRATC is determined by the law
  of diminishing returns.
• Diminishing Returns occurs when at least on input
  is fixed.
• In the long-run all inputs are variable.
• The LRATC is shaped by the firms returns to
  scale.
• Returns to Scale examine changes in the
  production function when all inputs are variable.

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Three Possible Shapes for the LRATC

• Increasing Returns to Scale Economies
  of Scale
• Decreasing Returns to Scale Diseconomies of
  scale
• Constant Returns to Scale
  Evidence points toward most industries exhibiting
  constant returns to scale. AP question normally
  assume constant returns to scale.(Firms will
  either enter or exit)

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Increasing Returns to Scale Economies of Scale

• As inputs are added, each input produces more
  output than the previous. The average output per
  input increases as inputs increase.
• Therefore, as output increases ATC decreases.

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Cause for Economics of ScaleIncreasing Returns
to Scale

• Technology
• Division of Labor
• Specialization of Inputs
• Quantity Discounts of Inputs
• Cross Availability of Inputs
• Shared Capital/Inputs/facilities/Transportation
• Use of production by-products

8
Decreasing Returns to ScaleDiseconomies of
Scale

• As inputs are added, each input produces less
  output than the previous. The average output per
  input decreases as inputs increase.
• Therefore, as output increases ATC increases.

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Causes for Diseconomies of ScaleDecreasing
Returns to Scale

• Competition of Factor Inputs
• Bureaucratic inefficiency/Top Heavy
• Union Activity

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Constant Returns to Scale

• As inputs are added, each input produces the same
  output as the previous. The average output per
  input remains the same as inputs increase.
• Therefore, as output increases ATC remains the
  same.

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Activity 3-7-1LRATC and Optimal Scale of aPlant

• The Optimal Scale of Plant is the scale that
  minimizes average cost.

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