Long-Run Costs

1Copyright ACDC Leadership 2015

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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

ACDC Leadership 2015

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

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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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