Learning Objectives: Costs in the Long Run LO1: Distinguish between the short run and the long run LO2: Understand why medium-sized firms are sometimes just as efficient as big firms LO3: Understand why big firms sometimes enjoy great cost advantages LO4: Understand why firms can sometimes be too big CHAPTER 7 7-1© 2012 McGraw-Hill Ryerson Limited

Economies of Scale cost advantages achieved as a result of large-scale operations firms in industries characterized by assembly-line production of standardized products tend to experience declining long-run average cost these industries are often dominated by a few large firms 7-2© 2012 McGraw-Hill Ryerson Limited LO3

Economies of Scale Reasons for Economies of Scale 1.big plants are able to exploit specialization of labour on a far greater scale than small plants 2.large-scale production encourages management specialization 3.large scale production encourages machine specialization 4.big firms enjoy pecuniary economies of scale 7-3© 2012 McGraw-Hill Ryerson Limited LO3

Economies of Scale Pecuniary Economies of Scale Lower cost of borrowing Buying in bulk Selling in bulk Economies of scale in marketing and advertising 7-4© 2012 McGraw-Hill Ryerson Limited LO3

Economies of Scale 7-5© 2012 McGraw-Hill Ryerson Limited LO3

Self-Test 7-6© 2012 McGraw-Hill Ryerson Limited Indicate the presence of either constant returns to scale or increasing returns to scale in each set of data. LO3 Total CostOutput Set 1$ Set

Diseconomies of Scale bureaucratic inefficiencies in management that result in decreasing returns to scale Decreasing Returns to Scale the situation in which a firm’s output increases by a smaller percentage than its inputs 7-7© 2012 McGraw-Hill Ryerson Limited LO3

Self-Test 7-8© 2012 McGraw-Hill Ryerson Limited Decide in each of the following cases (A–D) whether constant returns, economies, or diseconomies of scale exist. LO3 Inputs 1Inputs 2Output 1Output 2 A B C D