Today

1
Today

• Shifts in MC, ATC, and AVC curves.
• Production and cost in the long run.

2
Shifting the Short Run Cost Curves of the Firm

• They shift when
• The price of an input changes.
• There is a change in the level of the fixed
  inputs (a change in plant size).
• There is a change in the state of technology
  (meaning know-how).

3
Example Wages rise
MC
MC
/Q
ATC
ATC
Q
Variable costs rise at all levels of output. MC
shifts up. ATC shifts up. AVC (not shown) shifts
up.
4
Improvements in Technology
MC
/Q
MC
ATC
ATC
Q
Improvements in technology lead to lower costs.
(Could save only fixed costs, but usually MC will
fall.)
5
Different Plant Sizes

• Changing the short-run situation of the firm is
  best studied in the context of production and
  costs in the long-run.

6
Production and Costin the Long Run
7
Long Run

• The firms planning horizon in which it can
  choose any combination of inputs. It is not
  locked into past decisions in its plans for the
  long run.
• Firms can lock-in to any short-run situation in
  the long run.

8
Choice of Inputs

• Goods can be produced using many different
  combinations of inputs.
• Examples cleaning, building a house
• How does a firm decide which to use?
• Look at range of available production techniques
  for a given level of output.
• Calculate which costs least, given particular
  input prices.

9
Plant size

• Small plants achieve their lowest average total
  cost at a low level of output.
• Large plants achieve their lowest average total
  cost at a high level of output.
• In the SR, a firm is stuck with its current plant
  size.
• In the LR, a firm may choose any plant size (then
  it will be stuck at that one for future SR
  scenarios).

10
Average Costs for Various Plant Sizes
SRAC3
/Q
SRAC0
SRAC4
SRAC1
SRAC2
q
In the SR, this firm is using plant size 1. In
the LR it could choose any of these plant sizes.
11
ATC in the SR and the LR
SRAC3
c
/Q
SRAC0
SRAC4
SRAC1
SRAC2
f
b
e
a
d
qA
qB
q
In the SR, what is its AC of producing qA? qB? In
the LR, what is its AC of producing qA? qB?
12
Long Run Average Cost

• For any level of output, in the long run the firm
  will choose the plant size that gives the lowest
  possible average cost.
• At every q, LRAC ? SRAC. (why?)
• The LRAC curve is thus the lower envelope of the
  SRAC curves.

13
Long Run ATC
SRAC3
/Q
SRAC0
SRAC4
SRAC1
SRAC2
LRAC
q

14
With an Infinite Variety of Plant Sizes
/Q
LRAC
q

15
Economies of Scale

• How do you make cars differently if you plan to
  produce 100 cars per year compared to 500,000?

16
Very Small Auto Plants

• Assembly line too costly, uses too much K.
• Use proportionately more labor
• Keep fixed costs low

17
Large Auto Plant

• Assembly line, lots of machines and automation.
• High fixed costs, but spread over lots of units.
• The large plant can get the lowest average cost
  if it produces enough units.

18
Economies of Scale, Continued

• There are Economies of Scale when the LRAC of
  making a good falls as output grows.
• If you double output, total cost increases by
  less than double, average cost falls.
• ORIf you double all inputs, you get more than
  double the output.
• Also called Increasing Returns to Scale.
• Downward-sloping portion of LRAC curve.

19
Examples of EOS

• Almost all products have EOS at low levels of
  output. Which ones have EOS even at large levels
  of output?
• Auto manufacturing
• Coal mining
• Electricity generation distribution
• Retailing? (Wal-Mart)
• If small firms cannot compete against big ones,
  probably economies of scale are at work.

20
Constant Returns to Scale

• You can produce, say, 20 more and your costs go
  up 20.
• LRAC stays the same
• Sometimes called constant costs.
• Horizontal LRAC
• You should see firms of different sizes in the
  market.

21
Diseconomies of scale

• Expanding output by 20 will increase costs by,
  say, 25.
• LRAC is rising.
• Also called Decreasing Returns to Scale or
  increasing costs.
• Intuition The firm is so large it is
  inefficient.
• Firms this big will go out of business or scale
  down.

22
The Saucer-Shaped LRAC curve
/q
LRAC
q
q0
q1
Between 0 and q0 Economies of Scale Between q0
q1 Constant returns to scale Between q1 and ?
Diseconomies of Scale
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Be Sure to Know the Difference Between

• Decreasing Returns to Scale increasing all
  inputs by an equal results in increasing
  average costs, and
• Diminishing Marginal Returns holding one or more
  important factors constant, increasing the other
  factors by equal increments will eventually
  result in decreasing MP (increasing MC).

24
Shifting LRAC

• LRAC will shift any time there is
• a change in input prices
• a change in technology (know-how)
• Does the LRAC curve shift when plant size changes?

25
Example Wages fall
/q
LRAC
LRAC
q
Why would we expect the downward shift will not
be parallel?
26
Coming Up

• Begin study of profit maximization in the context
  of perfect competition.

27
Group Work

• Apply economies of scale to movie theaters.

28
More Screens

• The average number of movie screens per cinema
  has increased over the last several years. This
  seems to suggest there are increasing returns to
  scale that increasing the number of screens at
  each location leads to a lower average cost.

29
Increasing Returns to Scale at the Cinema

• List several reasons why a firms average costs
  would fall as the number of screens at the same
  location rises.
• Hint
• Comparing a cinema with 1 screen to one with 2
  screens, are all costs doubled?

30
Decreasing Returns to Scale at the Cinema?

• Even though the average number of screens per
  cinema has been rising, cinemas rarely have 20 or
  30 screens each, even in highly populated, urban
  areas. This seems to be evidence that the LRAC
  for a cinema eventually turns upward.
• List some reasons why a cinema would have
  difficulty it were to grow that large.