Production And Cost in the Long Run All inputs and all costs are variable Least Cost Rule To produce any given level of output, the firm will choose the input mix with the lowest cost Long-run total cost (LRTC) The cost of producing each quantity of output when the least-cost input mix is chosen in the long run

Production And Cost in the Long Run Long-run average total cost (LRATC) The cost per unit of output in the long run all inputs are variable LRTC ≤ TC LRATC ≤ ATC

Average Cost And Plant Size Plant - Collection of fixed inputs at a firm’s disposal Short run Cannot change the plant size Move along ATC curve Long run Choose among ATC curves Can change the plant size Produce at lowest possible ATC

Graphing the LRATC Curve Figure 5 Long-Run Average Total Cost 196 184 Dollars 1.00 2.00 3.00 $4.00 Units of Output 30 90 130 160 250 300 ATC1 LRATC ATC3 ATC0 ATC2 C D B A E 175 Use 0 automated lines Use 1 automated lines Use 2 automated lines Use 3 automated lines

The Shape of LRATC Economies of scale - LRATC decreases as output increases LRATC curve slopes downward More likely to occur at lower levels of output Spreading costs of Lumpy inputs Diseconomies of scale - LRATC increases as output increases LRATC curve slopes upward More likely at higher output levels

The Shape of LRATC Constant returns to scale - LRATC is unchanged as output increases LRATC curve is flat U-shape of LRATC curve Economies of scale at relatively low levels of output Constant returns to scale at some intermediate levels of output Diseconomies of scale at relatively high levels of output

Constant Returns to Scale The Shape Of LRATC Figure 6 The Shape Of LRATC Dollars 1.00 2.00 3.00 $4.00 130 184 LRATC Economies of Scale Constant Returns to Scale Diseconomies of Scale Units of Output

The Urge to Merge Minimum efficient scale (MES) Mergers The lowest output level at the minimum cost per unit in the long run Mergers Significant, unexploited economies of scale Because the market has too many firms for each to operate near its MES

The Urge to Merge Figure 7 LRATC for a Typical Firm in a Merger-Prone Industry 3. Other firms lose market share and end up at C Dollars Quantity per Month A B C LRATC $240 200 80 8,000 10,000 20,000 4.Price war - other firms must match the first-mover’s price; each firm ends up back at A - they suffer losses 1. With market quantity demanded fixed at 60,000, and six firms of equal market share, each operates at A 2. But any one firm can cut price slightly, increase market share, and operate with lower cost per unit, such as at the MES (point B) 5. Mergers to create three large firms would enable each to operate at its MES with less likelihood of price wars and losses