AP MICROECONOMICS UNIT #3 Production and Costs Lecture #3 Costs in the Long-Run

COSTS IN THE SHORT-RUN AND IN THE LONG-RUN Remember – Fixed costs in the short-run are variable costs in the long-run Long-run cost curves will look different than short- run cost curves Goal for a firm is to create the optimal plant size

LONG-RUN COST CURVES Long-run ATC curves are made up of segments of short-run The curve is made up of all points of tangency on an unlimited number of short-run ATC curves U-shape is caused by economies and diseconomies of large-scale production

Figure 7 Average Total Cost in the Short and Long Run ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory Cost $12,000 ATC in long run 1,200 Quantity of Cars per Day Copyright © 2004 South-Western

ECONOMIES OF SCALE The downslope is due to economies of mass production As plant size increases, factors can allow greater production at lower ATC

FACTORS CREATING ECONOMIES OF SCALE Labor specialization produces greater skill and efficiency Managerial specialization allows supervision of more workers and focus on an area of expertise Efficient capital promotes modernization and speed Start-up costs, marketing, advertising

DISECONOMIES OF SCALE Firms can become TOO BIG and start to increase ATC Upward slope of the curve Bureaucracy creates inefficiency More managers needed increases costs Workers can feel “lost” in a big plant

CONSTANT RETURNS TO SCALE Long-run ATC doesn’t change in some industries Output stays proportional to increased inputs

Figure 7 Average Total Cost in the Short and Long Run ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory Cost ATC in long run Economies of scale Diseconomies of scale 1,200 $12,000 1,000 10,000 Constant returns to scale Quantity of Cars per Day Copyright © 2004 South-Western

FIRM SIZE There is a lowest level of output where a firm can minimize long-run average costs Called Minimum Efficient Scale (MES) Depending on industry, both large and small firms can operate Natural Monopolies occur in industries where small firms cannot achieve MES because economies of scale are so big

Long-Run ATC Curve Any number of short-run optimum Average Total Costs Output Any number of short-run optimum size cost curves can be constructed 8-11

Long-Run ATC Curve Long-Run ATC The long-run ATC curve just Average Total Costs Output The long-run ATC curve just “envelopes” the short run ATCs 8-12

Long-run ATC curve where economies Long-Run ATC Shapes Economies Of Scale Constant Returns To Scale Diseconomies Of Scale Average Total Costs Long-Run ATC q1 q2 Output Long-run ATC curve where economies of scale exist 8-13

Long-Run ATC Shapes Long-Run ATC Economies Of Scale Diseconomies Of Scale Average Total Costs Long-Run ATC Output Long-run ATC curve where costs are lowest only when large firms are participating 8-14

Long-Run ATC Shapes Long-Run ATC Long-run ATC curve where economies Of Scale Diseconomies Of Scale Long-Run ATC Average Total Costs Output Long-run ATC curve where economies of scale exist, are exhausted quickly, and turn back up substantially 8-15