Long-Run Costs
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2
2010 Question 19
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Definition of the “Short-Run”• We will look at both short-run and long-run
production costs.• Short-run is NOT a set specific amount of
time.• The short-run is a period in which at least one
resource is fixed.– Plant capacity/size is NOT changeable
• In the long-run ALL resources are variable– NO fixed resources– Plant capacity/size is changeable
Today we will examine LONG-run costs.3Copyright
ACDC Leadership 2015
In the long run all resources are variable. Plant capacity/size can change.
Definition and Purpose of the Long Run
Why is this important?The Long-Run is used for planning. Firms use to identify
which plant size results in the lowest per unit cost. Ex: Assume a firm is producing 100 bikes with a fixed
number of resources (workers, machines, etc.). If this firm decides to DOUBLE the number of
resources, what will happen to the number of bikes it can produce?
There are only three possible outcomes: 1. Number of bikes will double (constant returns to scale)2. Bikes will more than double (increasing returns to scale)3. Bikes will less than double (decreasing returns to scale) 4Copyright
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Long Run ATCWhat happens to the average total costs of a
product when a firm increases its plant capacity?
Example of various plant sizes:•I make porch swings out of my garage with one saw•I rent out building, buy 5 saws, hire 3 workers•I rent a factory, buy 20 saws and hire 40 workers•I build my own plant and use robots to build swings•I build plants in every major city in the U.S.
***Firms want to MINIMIZE ATCLong Run ATC curve is made up of all the different short run ATC curves of various plant sizes. 5Copyright
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Long-Run ATC Curve
Ave
rage
Tot
al C
osts ATC-1
ATC-2ATC-3 ATC-4
ATC-5
Output
Any number of short-run optimum size cost curves can be constructed
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Long-Run ATC Curve
Long-RunATC
Ave
rage
Tot
al C
osts ATC-1
ATC-2ATC-3 ATC-4
ATC-5
Output
The long-run ATC curve just“envelopes” the short run ATCs
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Long Run AVERAGE Total Cost
8Quantity Cars
Costs
0 1 100 1,000 100,000 1,000,0000
Long Run Average Cost
Curve
Economies of Scale
Constant Returns to
Scale
Diseconomies of Scale
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Long Run Production Cost• Why do economies of scale occur?
– Labor specialization– Managerial specialization– Efficient capital
• Why do diseconomies of scale occur?– Difficulty in communicating and
coordinating– Workers can feel less attached/motivated
• Constant Returns to Scale8-9
Long-Run ATC Shapes
Output
Long-run ATC curve where economiesof scale exist
Ave
rage
Tot
al C
osts
Long-RunATC
EconomiesOf Scale
Constant ReturnsTo Scale
DiseconomiesOf Scale
q1 q2
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OutputLong-run ATC curve where costs arelowest only when large numbers are
participating
Ave
rage
Tot
al C
osts
EconomiesOf Scale
DiseconomiesOf Scale
Long-RunATC
Long-Run ATC Shapes
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OutputLong-run ATC curve where economiesof scale exist, are exhausted quickly,
and turn back up substantially
Ave
rage
Tot
al C
osts
Long-RunATC
EconomiesOf Scale
DiseconomiesOf Scale
Long-Run ATC Shapes
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Industry Structure• Minimum efficient scale (MES)
– Minimum level of output necessary to minimize LRATC
• Natural monopoly– One large firm
• Pure Competition– Many small firms
• Monopolistic Competition– Some small, some large firms
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