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2. KRUGMAN’S
Economics
for AP®
S E C O N D E D I T I O N

3. Section 10
Module 56

4. What You Will Learn in this Module
Explain why a firm’s costs may differ between the short run and the long run
Describe how a firm can enjoy economies of scale
Section 10 | Module 56

5. Short-Run versus Long-Run Costs
In the short run, fixed cost is completely outside the control of a firm.
But all inputs are variable in the long run: This means that in the long run fixed cost may also be varied.
In the long run, in other words, a firm’s fixed cost becomes a variable it can choose.
The firm will choose its fixed cost in the long run based on the level of output it expects to produce.
Section 10 | Module 56

6. Choosing the Level of Fixed Cost of Selena’s Gourmet Salsas
There is a trade-off between higher fixed cost and lower variable cost for any given output level, and vice versa.
But as output goes up, average total cost is lower with the higher amount of fixed cost.
Section 10 | Module 56

7. The Long-Run Average Total Cost Curve
The long-run average total cost curve shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output.
A firm may choose to increase their fixed costs in order to increase output. Over using space can cause supply issues so firms expand which increases their total fixed cost but may actually decrease their average total cost.
Section 10 | Module 56

8. Short-Run and Long-Run Average Total Cost Curves
Section 10 | Module 56

9. Returns to Scale
There are increasing returns to scale (economies of scale) when long-run average total cost declines as output increases.
There are decreasing returns to scale (diseconomies of scale) when long-run average total cost increases as output increases.
There are constant returns to scale when long-run average total cost is constant as output increases.
Section 10 | Module 56

10. Sunk Cost
A sunk cost is a cost that has already been incurred and is non-recoverable. A sunk cost should be ignored in decisions about future actions.
Sunk costs should be ignored in making decisions about future actions. Because they have already been incurred and are non-recoverable, they have no effect on future costs and benefits.
“There’s no use crying over spilled milk.”
Section 10 | Module 56

11. F Y I
There’s No Businesss Like Snow Business
There is a significant difference in total cost that arise from making different choices about fixed cost.
Washington, D.C. has fewer snowfalls than Chicago and therefore has fewer snowplows.
Washington, D.C. and Chicago are like two different businesses who have different expectations about output (snow removal) and make different decisions about the level of fixed cost.
Section 10 | Module 56

12. Summing Up Costs
Section 10 | Module 56

13. Summary
In the long run, a producer can change its fixed input and its level of fixed cost. The long-run average total cost curve shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost at each level of output.
As output increases, there are increasing returns to scale if long-run average total cost declines; decreasing returns to scale if it increases; and constant returns to scale if it remains constant. Scale effects depend on the technology of production.
A sunk cost is a cost that has already been incurred and is non-recoverable. A sunk cost should be ignored in a decision about future actions.
Section 10 | Module 56