AP Microeconomics Warm Up: When can a business expand? Are businesses guaranteed continued profits when they expand? Explain.

Long Run & short run are different mainly because… Short Run = fixed capacity (cap. gds) therefore costs will increase; no entry or exit. Long Run = ALL inputs are variable; with expansion costs can go up, go down, stay the same.

Short Run Review: We know that the shapes of short-run cost curves are u-shaped as a result of the assumption that they are affected by a fixed factor of production. Costs go down in the beginning, but because of the fixed scale of operations they will reach a low point and then increase at every point after that.

Side-by-Side Graphs Since this firm is making a profit, it can reinvest that profit and expand production!! The Volume of competition in perfect competition pushes all firms to expand when possible! Market Cost & Rev ($) OutputQuantity Price ($) Firm S D P*PMR MC ATC AVC QQ Eco Profit

Profit in SR = Expand to LR Long-run cost curves contain no such assumption. Firms in the long-run can either triple production or exit an industry altogether. As a result, their long-run average cost curve is made up of several short- run average cost curves at various scales of production.

Like this: Cost & Rev ($) Output SRMC 1 SRAC 1 P* Output Quantity 1 Since this firm is making a profit, it can expand its production. One of three things can happen: 1. Get More Efficient (costs ↓) 2. Get Less Efficient (costs ↑) 3. No change in efficiency

Like this: Cost & Rev ($) Output SRMC 1 SRAC 1 P* Output Quantity 1 SRMC 2 SRAC 2 Output Quantity 2 There’s an important reason we are now using the SRMC=SRAC point to identify all subsequent firm outputs. SRMC 3 SRAC 3 Output Quantity 3 SRMC 4 SRAC 4 Output Quantity 4

Like this: Cost & Rev ($) Output SRMC 1 SRAC 1 P* Output Quantity 1 SRMC 2 SRAC 2 Output Quantity 2 SRMC 3 SRAC 3 Output Quantity 3 SRMC 4 SRAC 4 Output Quantity 4 SRMC = SRAC represents break even, as long as price is above this point a firm is making profits and can expand.

Like this: Cost & Rev ($) Output SRAC 1 Output Quantity 1 SRAC 2 Output Quantity 2 SRAC 3 Output Quantity 3 SRAC 4 Output Quantity 4 LRAC

Long Run Average Costs The Long Run ATC (LRAC): “envelopes” all of the SRAC curves; its shape depends on how costs vary with differing scales of operations.

Increasing Returns to Scale An increase in a firm’s scale of production leads to lower average costs per unit produced. [bigger is better] Ex) automobile manufacturing, public transportation bus, airline industry.

Constant Returns to Scale An increase in a firm’s scale of production has no effect on average costs per unit produced.

Decreasing Returns to Scale An increase in a firm’s scale of production leads to higher average costs per unit produced. Ex) bureaucratic inefficiencies, top- heavy management, sometimes union drive industries.

The low point of a firm’s LRAC: Unit Costs Output Long-run ATC Economies of scale

The low point of a firm’s LRAC: Unit Costs Output Long-run ATC Economies of scale Constant returns to scale

The low point of a firm’s LRAC: Unit Costs Output Long-run ATC Economies of scale Diseconomies of scale Constant returns to scale (decreasing costs as production increases) (constant - unchanging costs as production increases) (increasing costs as production increases)

The low point of a firm’s LRAC: Is called Optimum Scale: The scale of plant that minimizes average cost. Once a firm has expanded beyond this point, it should scale back production or exit the industry.