1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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