04 economies of scale

Bellringer Chapter 141. Consider some of your short term goals (within

1 year)2. Consider some of your long term goals (when

you get to be old like Klein)3. How are marginal costs different for an MP3 or

smart phone app than airline travel or manufacturing?

Which curves are MR, AFC, AVC, ATC?

Short run Fixed costs

• Factory in long run?• Over years, all costs are variable

THE COSTS OF PRODUCTION 4

Costs in the Short Run & Long Run

• Short run: Some inputs are fixed (e.g., factories, land). The costs of these inputs are FC.

• Long run: All inputs are variable (e.g., firms can build more factories, or sell existing ones).

• In the long run, ATC at any Q is cost per unit using the most efficient mix of inputs for that Q (e.g., the factory size with the lowest ATC).

THE COSTS OF PRODUCTION 5

EXAMPLE 3: LRATC with 3 factory Sizes

ATCS ATCM ATCL

Q

AvgTotalCost

Firm can choose from 3 factory sizes: S, M, L.

Each size has its own SRATC curve.

The firm can change to a different factory size in the long run, but not in the short run.

THE COSTS OF PRODUCTION 6

EXAMPLE 3: LRATC with 3 factory Sizes

ATCS ATCM ATCL

Q

AvgTotalCost

QA QB

LRATC

To produce less than QA, firm will choose size S in the long run. To produce between QA and QB, firm will choose size M in the long run. To produce more than QB, firm will choose size L in the long run.

THE COSTS OF PRODUCTION 7

A Typical LRATC Curve

Q

ATCIn the real world, factories come in many sizes, each with its own SRATC curve.

So a typical LRATC curve looks like this:

LRATC

THE COSTS OF PRODUCTION 8

How ATC Changes as the Scale of Production Changes

Economies of scale: ATC falls as Q increases.

Constant returns to scale: ATC stays the same as Q increases.

Diseconomies of scale: ATC rises as Q increases.

LRATC

Q

ATC

THE COSTS OF PRODUCTION 9

Economies of Scale Causes• Economies of scale occur when increasing production

allows greater specialization• More common when Q is low. • Capital goods (machinery)• Specialization of labor (& movement of labor)• Transportation or research network

On the consumer side• Place where consumers benefit from

economies of scale?• That is, buying power means lower marginal

price (cost)

Are economies of scale positive for consumers?

• In your groups, brainstorm 2 reasons why they are positive

• 2 reasons why they are negative (think about small business competition)

THE COSTS OF PRODUCTION 13

Diseconomies of Scale Causes

Diseconomies of scale are due to coordination problems in large organizations. More common when Q is high.

According to the figure, suppose the firm currently operates on the minimum of ATCB. If it increases production, but not all the way to N, then short-run average total cost

a. and long-run average total cost increase.b. and long-run average total cost decrease.c. rises and long-run average total cost is unchanged.d. is unchanged and long-run average total cost increases.

According to the figure, suppose the firm currently operates on the minimum of ATCA, if the firm continues to produce until M, they would benefit from:

a. diseconomies of scaleb. economies of scalec. constant returns to scaled. short run cost increases