Econ 101: Principles of Microeconomics · Econ 101: Principles of Microeconomics Chapter 12 -...

Econ 101: Principles of MicroeconomicsChapter 12 - Behind the Supply Curve - Inputs and Costs

Fall 2010

Herriges (ISU) Ch. 12 Behind the Supply Curve Fall 2010 1 / 30

Outline

1 The Production Function

2 Marginal Cost and Average Cost

3 Short-Run versus Long-Run Costs

Overview

In this chapter we turn our attention to the firm.

A firm is an organization that produces goods or services for sale.

We will begin by characterizing the relationship between the firm’sinputs and the quantity of outputs it produces.

The production function describes the relationship between thequantity of inputs and the quantity of outputs that the firm produces.

Basic characteristics of the production function has implications forthe cost structure for the firm, which in turn has implications for thefirm’ ultimate supply function.

Overview

Basic characteristics of the production function has implications forthe cost structure for the firm

, which in turn has implications for thefirm’ ultimate supply function.

Overview

The Production Function

The Short Run and the Long Run

It is useful to categorize firms’ decisions into

- Long-run decisions

–involves a time horizon long enough for a firm tovary all of its inputs

- Short-run decisions–involves any time horizon over which at least oneof the firm’s inputs cannot be varied

To guide the firm over the next several years, manager must use thelong-run view

To determine what the firm should do next week, the short run viewis best.

- Long-run decisions–involves a time horizon long enough for a firm tovary all of its inputs

- Short-run decisions

–involves any time horizon over which at least oneof the firm’s inputs cannot be varied

Production in the Short Run

In the short-run, the firm’s inputs can be divided into one of twocategories

1 Fixed inputs

- These are inputs whose quantity is constant for some period of time(regardless of how much output is produced).

- Typically, fixed inputs will include land and machinery, though they canalso include certain types of labor (due to contracts).

2 Variable inputs

- These are inputs whose quantity the firm can vary, even in the shortrun.

- Examples of variable inputs often include labor, energy, fuel, etc.

When firms make short-run decisions, there is nothing they can doabout their fixed inputs; i.e., they are stuck with whatever quantitythey have.

However, they can make choices about their variable inputs.

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

1 Fixed inputs

2 Variable inputs

Total Product

To fix ideas, suppose we have a firm whose only variable input is labor

All other inputs (capital, land, raw materials, etc.) we will assume fornow are fixed.

Total product is the maximum quantity of output that can beproduced from a given combination of inputs.

The total product curve shows how the quantity of output depends onthe quantity of variable input, for a given quantity of the fixed input.

We would generally expect the total product curve to be increasing;i.e., as the quantity of the variable input increases, we would expecttotal output to increase.

Total Product

We would generally expect the total product curve to be increasing

;i.e., as the quantity of the variable input increases, we would expecttotal output to increase.

Total Product

Consider John’s Woodworking Shop Again

Units of Labor Total Product0 0

1 102 353 804 1605 1936 2187 2398 257

Units of Labor Total Product0 01 10

2 353 804 1605 1936 2187 2398 257

Units of Labor Total Product0 01 102 35

3 804 1605 1936 2187 2398 257

Units of Labor Total Product0 01 102 353 80

4 1605 1936 2187 2398 257

Units of Labor Total Product0 01 102 353 804 160

5 1936 2187 2398 257

Units of Labor Total Product0 01 102 353 804 1605 193

6 2187 2398 257

Units of Labor Total Product0 01 102 353 804 1605 1936 218

7 2398 257

Units of Labor Total Product0 01 102 353 804 1605 1936 2187 239

Units of Labor Total Product0 01 102 353 804 1605 1936 2187 2398 257

The Total Product Curve

Marginal Product

Notice that the Total Product curve is always increasing in this case,but that it’s slope is not the same throughout.

- Initial the slope is increasing- but eventually it starts to flatten out.

The slope of the Total Product Curve is the Marginal Product oflabor.

Formally,

Marginal Product of Labor (MPL) =Change in Quantity of Output

Change in Quantity of Labor

Tells us the rise in output produced when one more worker is hired

Marginal Product

- Initial the slope is increasing

- but eventually it starts to flatten out.

Formally,

Marginal Product

Formally,

Marginal Product

Formally,

Marginal Product

Formally,

Marginal Product

Formally,

Marginal Product

Formally,

Units of Labor Total Product Marginal Product0 0

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

1 1025

2 3545

3 8080

4 16033

5 19325

6 21821

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

2 3545

3 8080

4 16033

5 19325

6 21821

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

252 35

3 8080

4 16033

5 19325

6 21821

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

252 35

453 80

4 16033

5 19325

6 21821

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

252 35

453 80

804 160

5 19325

6 21821

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

252 35

453 80

804 160

335 193

6 21821

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

252 35

453 80

804 160

335 193

256 218

7 23918

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

101 10

252 35

453 80

804 160

335 193

256 218

217 239

101 10

252 35

453 80

804 160

335 193

256 218

217 239

188 257

The Marginal Product Curve

Marginal Returns To Labor

As more and more workers are hired, the MPL is at first increasing

- This is known as increasing returns to labor- This is typically due to the returns to specialization- It can also arise due to minimum labor requirements for equipment.

Eventually, however, the MPL starts to decline

- This is known as diminishing returns to labor- This arises as the gains from specialization are exhausted and- The constraints caused by the fixed inputs start to bind

This pattern of MPL (and for other inputs) is thought to hold formost industries.

Consider the problem of a woodworking shop.

- This is known as increasing returns to labor

- This is typically due to the returns to specialization- It can also arise due to minimum labor requirements for equipment.

- This is known as increasing returns to labor- This is typically due to the returns to specialization

- It can also arise due to minimum labor requirements for equipment.

- This is known as diminishing returns to labor

- This arises as the gains from specialization are exhausted and- The constraints caused by the fixed inputs start to bind

- This is known as diminishing returns to labor- This arises as the gains from specialization are exhausted and

- The constraints caused by the fixed inputs start to bind

Marginal Cost and Average Cost

Production and Firm Costs

Understanding the nature of a firm’s production function is importantin that it has implications for the firm’s costs.

In the short run, the firm’s costs can be divided into two broadcategories:

1 Total Fixed costs (TFC): These are costs that do not depend upon thequantity of output produced.

- These costs are typically associated with fixed inputs.- Examples of fixed costs might be the rent paid for the firm’s building or

equipment rentals.

2 Total Variable costs (TVC): These are costs that depend on thequantity output produced.

- As the name suggests, these are costs associated with the variableinputs.

- In the case of John’s Woodworking shop, the TVC = w × L where wdenotes the wage rate.

Total Costs = TFC + TVC.

equipment rentals.

- These costs are typically associated with fixed inputs.

- Examples of fixed costs might be the rent paid for the firm’s building orequipment rentals.

equipment rentals.

John’s Cost Structure

Suppose that John has a TFC of $5000 and pays a wage rate of$1200 per week

Units of Total Total Fixed Total Variable TotalLabor Output Cost (TFC) Costs (TVC) Costs (TC)

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $5000

1 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $6200

2 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $7400

3 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $8600

4 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $9800

5 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $11000

6 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $12200

7 239 $5000 $8400 $134008 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $13400

8 257 $5000 $9600 $14600

0 0 $5000 $0 $50001 10 $5000 $1200 $62002 35 $5000 $2400 $74003 80 $5000 $3600 $86004 160 $5000 $4800 $98005 193 $5000 $6000 $110006 218 $5000 $7200 $122007 239 $5000 $8400 $134008 257 $5000 $9600 $14600

The Cost Curves

Marginal and Average Cost Curves

While the breakdown of Total Cost into Total Fixed and TotalVariable Costs is helpful, two other measures of cost will be evenmore useful:

1 Marginal Cost: Measures the additional cost of producing one moreunit of a good or service.

2 Average Cost: Measures the average cost per unit of the good orservice (i.e., the costs averaged over all of the output produced by thefirm).

Understanding the distinction between these two concepts will be keyto finding the optimal level of production for the firm.

We’ll start with average cost

Average CostsThere are three types of average costs

1 Average Fixed Costs (AFC) = Total Fixed Costs divided by Output

AFC =TFC

Since the numerator is fixed, AFC will decline as output increases.2 Average Variable Costs (AVC) = Total Variable Costs divided by

Output

AVC =TVC

- Since TVC is initial slowing down as output increases (with increasingreturns to labor), AVC will initially fall as output increases.

- As TVC starts to increase more rapidly with output (with diminishingreturns to labor), AVC will start to increase with output.

3 Average Total Costs (ATC) = Total Costs divided by Output

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Since the numerator is fixed, AFC will decline as output increases.

2 Average Variable Costs (AVC) = Total Variable Costs divided byOutput

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

AFC =TFC

Output

AVC =TVC

ATC =TC

Q= AFC + AVC (3)

John’s Average Costs

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.00

2 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.43

3 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.50

4 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.25

5 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.99

6 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.96

7 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.07

8 257 $19.46 $37.35 $56.81

Units of Labor Total Product AFC AVC ATC1 10 $500.00 $120.00 $620.002 35 $142.86 $68.57 $211.433 80 $62.50 $45.00 $107.504 160 $31.25 $30.00 $61.255 193 $25.91 $31.09 $56.996 218 $22.94 $33.03 $55.967 239 $20.92 $35.15 $56.078 257 $19.46 $37.35 $56.81

The Average Cost Curves

Marginal Costs

Another way of looking at the firm’s cost structure is to look at itsMarginal Costs; i.e., how it’s costs increase as output increases.

Formally:

MC =∆TC

∆Q(4)

If we look at John’s Woodworking Shop we have

Output Total Cost ∆Q ∆TC MC0 5000

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 120

35 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 48

80 8600 45 1200 27160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15

193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36

218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48

239 13400 21 1200 57257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57

257 14600 18 1200 67

Marginal Costs

Formally:

MC =∆TC

∆Q(4)

10 6200 10 1200 12035 7400 25 1200 4880 8600 45 1200 27

160 9800 80 1200 15193 11000 33 1200 36218 12200 25 1200 48239 13400 21 1200 57257 14600 18 1200 67

Adding in the MC Curve

Patterns in the MC and AC Curves

Notice that the MC curve is

- Initially declining- this is due to increasing returns to labor- Eventually increasing- this is due to diminishing returns to labor

The minimum-cost output, Qmin, is the quantity at which the averagetotal cost is lowest.

- This is at the bottom of the ATC curve.- and occurs where ATC=MC

At outputs less than Qmin, ATC > MC and ATC is falling.

At outputs greater than Qmin, ATC < MC and ATC is rising.

- Initially declining

- this is due to increasing returns to labor- Eventually increasing- this is due to diminishing returns to labor

- Initially declining- this is due to increasing returns to labor

- Eventually increasing- this is due to diminishing returns to labor

- Initially declining- this is due to increasing returns to labor- Eventually increasing

- this is due to diminishing returns to labor

- This is at the bottom of the ATC curve.

- and occurs where ATC=MC

Short-Run versus Long-Run Costs

Production Costs in the Long Run

Up until now, we have been focussing on the short-run, with some ofthe firm’s inputs held fixed.

In the long run, costs behave differently

Firm can adjust all of its inputs in any way it wantsIn the long run, there are no fixed inputs or fixed costs; i.e. all inputsand all costs are variable

Firm must decide what combination of inputs to use in producing anylevel of output

The firms goal is to earn the highest possible profit

To do this, it must follow the least cost rule; i.e., to produce any givenlevel of output the firm will choose the input mix with the lowest cost

This yields a Long-Run Average Total Cost Curve; i.e., therelationship between the output and the ATC when fixed costs arechosen to minimize total cost for each level of output.

Firm can adjust all of its inputs in any way it wants

In the long run, there are no fixed inputs or fixed costs; i.e. all inputsand all costs are variable

This yields a Long-Run Average Total Cost Curve

; i.e., therelationship between the output and the ATC when fixed costs arechosen to minimize total cost for each level of output.

Consider John’s Woodworking Shop

Suppose that in our first production function, we assumed that Johnhad only one set of tools (e.g., 1 table saw, 1 drill press, and 1 routertable).

We’ll call this one unit of capital

The tools (and the space to house his tools) constitute fixed costs forJohn in the short-run.

In the long-run, John must decide whether or not he wants to expandhis capital stock

The trade-off is that additional capital will avoid worker congestion,but imposes a large fixed cost on the firm.

At low levels of production, having just one set of tools is not a bindingconstraint and John would rather avoid the additional capital costs.At higher levels of production, additional capital will avoid congestionproblems and the capital costs are spread out over more units ofproduction.

At low levels of production, having just one set of tools is not a bindingconstraint and John would rather avoid the additional capital costs.

At higher levels of production, additional capital will avoid congestionproblems and the capital costs are spread out over more units ofproduction.

Different Levels of Capital

Labor Units of CapitalUnits of Labor Capital = 1 Capital = 2 Capital = 3

0 0 0 0

1 10 10 102 35 39 393 80 92 1014 160 184 2025 193 284 3146 218 397 4397 239 443 5718 257 478 709

0 0 0 01 10 10 10

2 35 39 393 80 92 1014 160 184 2025 193 284 3146 218 397 4397 239 443 5718 257 478 709

0 0 0 01 10 10 102 35 39 39

3 80 92 1014 160 184 2025 193 284 3146 218 397 4397 239 443 5718 257 478 709

0 0 0 01 10 10 102 35 39 393 80 92 101

4 160 184 2025 193 284 3146 218 397 4397 239 443 5718 257 478 709

0 0 0 01 10 10 102 35 39 393 80 92 1014 160 184 202

5 193 284 3146 218 397 4397 239 443 5718 257 478 709

0 0 0 01 10 10 102 35 39 393 80 92 1014 160 184 2025 193 284 314

6 218 397 4397 239 443 5718 257 478 709

0 0 0 01 10 10 102 35 39 393 80 92 1014 160 184 2025 193 284 3146 218 397 439

7 239 443 5718 257 478 709

0 0 0 01 10 10 102 35 39 393 80 92 1014 160 184 2025 193 284 3146 218 397 4397 239 443 571

8 257 478 709

0 0 0 01 10 10 102 35 39 393 80 92 1014 160 184 2025 193 284 3146 218 397 4397 239 443 5718 257 478 709

The Corresponding ATC Figures are Given by

John’s Capital Stock ChoiceThe level of capital stock John chooses depends on his expected level ofoutput

If Capital Stock Can be Varied Continuously, We Get

Returns to Scale

LRATC curves for industries usually exhibit three basic phases:

1 Increasing Returns to Scale: Output range with declining LRATC

This is also known as economies of scaleEconomies of scale often arise due to the gains from specialization.The greatest opportunities for increased specialization occur when afirm is producing at a relatively low level of outputEconomies of scale can also arise due to minimum size requirements forcertain types of equipment.

2 Constant Returns to Scale: Output range with constant LRATC

Over some range of production, size may not matter and firms of thesame size will be equally cost-effective.

3 Decreasing Returns to Scale: Output range with increasing LRATC

This is also known as diseconomies of scaleAs output continues to increase, most firms will reach a point wherebigness begins to cause problemsThis is true even in the long run, when the firm is free to increase itsplant size as well as its workforceDiseconomies of scale are more likely at higher output levels

Returns to Scale

LRATC curves for industries usually exhibit three basic phases:1 Increasing Returns to Scale: Output range with declining LRATC

Returns to Scale

This is also known as economies of scale

Economies of scale often arise due to the gains from specialization.The greatest opportunities for increased specialization occur when afirm is producing at a relatively low level of outputEconomies of scale can also arise due to minimum size requirements forcertain types of equipment.

Returns to Scale

This is also known as economies of scaleEconomies of scale often arise due to the gains from specialization.

The greatest opportunities for increased specialization occur when afirm is producing at a relatively low level of outputEconomies of scale can also arise due to minimum size requirements forcertain types of equipment.

Returns to Scale

This is also known as economies of scaleEconomies of scale often arise due to the gains from specialization.The greatest opportunities for increased specialization occur when afirm is producing at a relatively low level of output

Economies of scale can also arise due to minimum size requirements forcertain types of equipment.

Returns to Scale

This is also known as diseconomies of scale

As output continues to increase, most firms will reach a point wherebigness begins to cause problemsThis is true even in the long run, when the firm is free to increase itsplant size as well as its workforceDiseconomies of scale are more likely at higher output levels

Returns to Scale

This is also known as diseconomies of scaleAs output continues to increase, most firms will reach a point wherebigness begins to cause problems

This is true even in the long run, when the firm is free to increase itsplant size as well as its workforceDiseconomies of scale are more likely at higher output levels

Returns to Scale

This is also known as diseconomies of scaleAs output continues to increase, most firms will reach a point wherebigness begins to cause problemsThis is true even in the long run, when the firm is free to increase itsplant size as well as its workforce

Diseconomies of scale are more likely at higher output levels

Returns to Scale

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