topics covered: production in the lr costs in the lr lrac curves lrmc curves the relationship...

Topics Covered:

• Production in the LR• Costs in the LR• LRAC curves• LRMC Curves• The relationship between SRAC and LRAC curves

Production in the Long runProduction in the Long runProduction in the Long runProduction in the Long run

• All factors variable in long runAll factors variable in long run

• The scale of production:The scale of production:

– constant returns to scaleconstant returns to scale

– increasing returns to scaleincreasing returns to scale

– decreasing returns to scaledecreasing returns to scale

• Economies of scaleEconomies of scale– specialisation & division of labourspecialisation & division of labour

– indivisibilitiesindivisibilities

– container principlecontainer principle

– greater efficiency of large machinesgreater efficiency of large machines

– by-productsby-products

– multi-stage productionmulti-stage production

– organisational & administrative economiesorganisational & administrative economies

– financial economiesfinancial economies

• Diseconomies of scaleDiseconomies of scale

Production in the Long runProduction in the Long runProduction in the Long runProduction in the Long run

• External economies and diseconomies of External economies and diseconomies of scalescale

• LocationLocation– balancing the distance from suppliers and balancing the distance from suppliers and

consumersconsumers– importance of transport costsimportance of transport costs

• Optimum combination of factorsOptimum combination of factorsMPPa/Pa = MPPb/Pb ... = MPPn/PnMPPa/Pa = MPPb/Pb ... = MPPn/Pn

• Decision making in different time periodsDecision making in different time periods– very short run, short run, long run and very very short run, short run, long run and very

long runlong run– decisions can be made for all time periods decisions can be made for all time periods at at

the same timethe same time

Production in the Long runProduction in the Long runProduction in the Long runProduction in the Long run

Costs in the Long runCosts in the Long runCosts in the Long runCosts in the Long run

• Long-run average costsLong-run average costs– shape of the shape of the LRACLRAC curve curve– assumptions behind the curveassumptions behind the curve

Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves

OutputO

Co

sts

(a)(a) Economies of scale Economies of scale

LRAC

OutputO

Co

sts

(b)(b) Diseconomies of scale Diseconomies of scale

LRAC

Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves

OutputO

Co

sts

(c)(c) Constant costs Constant costs

LRAC

Alternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curvesAlternative long-run average cost curves

A typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curve

OutputO

Co

sts

LRAC

OutputO

Co

sts

LRACEconomiesof scale

Constantcosts

Diseconomiesof scale

A typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curveA typical long-run average cost curve

Costs in the Long runCosts in the Long runCosts in the Long runCosts in the Long run

• Long-run average costsLong-run average costs– shape of the shape of the LRACLRAC curve curve– assumptions behind the curveassumptions behind the curve

• Long-run marginal costsLong-run marginal costs

Long-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costs

OutputO

Co

sts

(a)(a) Economies of scale Economies of scale

LRAC

LRMC

OutputO

Co

sts

(b)(b) Diseconomies of scale Diseconomies of scale

LRAC

LRMC

Long-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costs

OutputO

Co

sts

(c)(c) Constant costs Constant costs

LRAC = LRMC

Long-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costs

OutputO

Co

sts

(d)(d) Initial economies of scale, then diseconomies of scale Initial economies of scale, then diseconomies of scale

LRMC

LRAC

Long-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costsLong-run average and marginal costs

Costs in the Long runCosts in the Long runCosts in the Long runCosts in the Long run

• Long-run average costsLong-run average costs– shape of the shape of the LRACLRAC curve curve– assumptions behind the curveassumptions behind the curve

• Long-run marginal costsLong-run marginal costs

• Relationship between long-run and short-Relationship between long-run and short-run average costsrun average costs– the envelope curvethe envelope curve

Deriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed size

SRAC1

Co

sts

OutputO

1 factory

Deriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed size

SRAC1

SRAC2

Co

sts

OutputO

2 factories

Deriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed size

SRAC1

SRAC3SRAC2

Co

sts

OutputO

3 factories

Deriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed size

SRAC1

SRAC3SRAC2

SRAC4

SRAC5

Co

sts

OutputO

5 factories

4 factories

Deriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed sizeDeriving long-run average cost curves: factories of fixed size

SRAC1

SRAC3SRAC2

SRAC4

SRAC5

LRAC

Co

sts

OutputO

Deriving a long-run average cost curve: choice of factory sizeDeriving a long-run average cost curve: choice of factory sizeDeriving a long-run average cost curve: choice of factory sizeDeriving a long-run average cost curve: choice of factory sizeC

ost

s

OutputO

Examples of short-runaverage cost curves

Deriving a long-run average cost curve: choice of factory sizeDeriving a long-run average cost curve: choice of factory sizeDeriving a long-run average cost curve: choice of factory sizeDeriving a long-run average cost curve: choice of factory size

LRAC

Co

sts

OutputO

Costs in the Long runCosts in the Long runCosts in the Long runCosts in the Long run

• Long-run average costsLong-run average costs– shape of the shape of the LRACLRAC curve curve– assumptions behind the curveassumptions behind the curve

• Long-run marginal costsLong-run marginal costs

• Relationship between long-run and short-Relationship between long-run and short-run average costsrun average costs– the envelope curvethe envelope curve

• Long-run cost curves in practiceLong-run cost curves in practice

Costs in the Long runCosts in the Long runCosts in the Long runCosts in the Long run

• Long-run average costsLong-run average costs– shape of the shape of the LRACLRAC curve curve– assumptions behind the curveassumptions behind the curve

• Long-run marginal costsLong-run marginal costs

• Relationship between long-run and short-Relationship between long-run and short-run average costsrun average costs– the envelope curvethe envelope curve

• Long-run cost curves in practiceLong-run cost curves in practice– the evidencethe evidence

Costs in the Long runCosts in the Long runCosts in the Long runCosts in the Long run

• Long-run average costsLong-run average costs– shape of the shape of the LRACLRAC curve curve– assumptions behind the curveassumptions behind the curve

• Long-run marginal costsLong-run marginal costs

• Relationship between long-run and short-Relationship between long-run and short-run average costsrun average costs– the envelope curvethe envelope curve

• Long-run cost curves in practiceLong-run cost curves in practice– the evidencethe evidence– minimum efficient plant sizeminimum efficient plant size