SAYRE | MORRIS Seventh Edition Costs in the Long Run CHAPTER 7 7-1© 2012 McGraw-Hill Ryerson Limited

The Long Run Long Run the period of time during which all inputs are variable all production processes operate in the short run, and diminishing marginal productivity applies in the long run, all costs are variable and diminishing marginal productivity does not apply a firm can plan as if it is in the long run, but it always operates in the short run 7-2© 2012 McGraw-Hill Ryerson Limited LO1

The Long Run Long Run Average Cost Curve a graphical representation of the per unit costs of production in the long run Constant Returns to Scale the situation in which a firm’s output increases by the same percentage as the increase in its inputs 7-3© 2012 McGraw-Hill Ryerson Limited LO2

Average Costs of Production in Four Plant Sizes 7-4© 2012 McGraw-Hill Ryerson Limited LO2

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 7-5© 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 7-6© 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 7-7© 2012 McGraw-Hill Ryerson Limited LO3

Economies of Scale 7-8© 2012 McGraw-Hill Ryerson Limited LO3

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 7-9© 2012 McGraw-Hill Ryerson Limited LO3

LRAC Curve under Diseconomies of Scale 7-10© 2012 McGraw-Hill Ryerson Limited LO2

Changes in Short Run and Long Run Costs Technological Improvement changes in production techniques that reduce the costs of production causes a decrease in short-run costs since long-run average cost curve is derived from short-run cost curves, the long-run average costs also decrease 7-11© 2012 McGraw-Hill Ryerson Limited LO5

The Right Size of Firm 7-12© 2012 McGraw-Hill Ryerson Limited LO6

The Right Size of Firm 7-13© 2012 McGraw-Hill Ryerson Limited LO6

Can a Market Be Too Small Minimum Efficient Scale (MES) the smallest sized plant capable of achieving the lowest long-run average cost of production 7-14© 2012 McGraw-Hill Ryerson Limited LO7

Can a Market Be Too Small 7-15© 2012 McGraw-Hill Ryerson Limited LO7