1. Production And Cost in the Long Run
In the long run, costs behave differently
Firm can adjust all of its inputs in any way it wants
In the long run, there are no ___ inputs or ___ costs
All inputs and all costs are ______
Firm must decide what combination of inputs to use in producing any level of output
The firm’s goal is to ___________
To do this, it must follow ______________
To produce any given level of output the firm will choose the input mix with the lowest cost

2. Different ways to wash 196 cars per day
Capital cost =$75 per day
Labor cost = $60 per unit per day
Method
Quantity of Capital
Quantity of Labor
Cost A 9 B 1 6 C 2 4 D 3

3. Production And Cost in the Long Run
Long-run total cost
The cost of producing each quantity of output when the least-cost input mix is chosen in the long run
Long-run average total cost
The cost per unit of output in the long run, when all inputs are variable
The long-run average total cost (LRATC)
Cost per unit of output in the long-run

4. Long-Run and Short-Run Costs for Spotless Car Wash
Output
TC($)
LRTC($)
LRATC($) 75 30
135
100 90
195
130
255
161
315
184
375
360
196
435
390
250
650
300
1,200

5. The Relationship Between Long-Run And Short-Run Costs
For some output levels, LRTC is ______ than TC
Long-run total cost of producing a given level of output can be less than or equal to, but never greater than, short-run total cost (LRTC ≤ TC)
Long-run average cost of producing a given level of output can be less than or equal to, but never greater than, short–run average total cost (LRATC ≤ ATC)

6. Average Cost And Plant Size
Collection of fixed inputs at a firm’s disposal
Can distinguish between the long run and the short run
In the long run, the firm can change the size of its plant
In the short run, it is stuck with its current plant size
ATC curve tells us how average cost behaves in the short run, when the firm uses a plant of a given size
To produce any level of output, it will always choose that ATC curve—among all of the ATC curves available—that enables it to produce at lowest possible average total cost
This insight tells us how we can graph the firm’s LRATC curve

7. Figure 7: Long-Run Average Total Cost
196
184
Dollars
1.00
2.00
3.00
$4.00
Units of Output 30 90
130
161
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

8. Graphing the LRATC Curve
A firm’s LRATC curve combines portions of each ATC curve available to firm in the long run
For each output level, firm will always choose to operate on the ATC curve with ________________
In the short run, a firm can only move along its current ATC curve
However, in the long run it can move from one ATC curve to another by varying the size of its plant
Will also be moving along its LRATC curve

9. Economics of Scale Economics of scale
Long-run average total cost _____ as output increases
When an increase in output causes LRATC to decrease, we say that the firm is enjoying economics of scale
The more output produced, the lower the cost per unit
When long-run total cost rises proportionately less than output, production is characterized by economies of scale
LRATC curve slopes ________

10. Figure 8: 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

11. Gains From Specialization
One reason for economies of scale is gains from specialization
The greatest opportunities for increased specialization occur when a firm is producing at a relatively low level of output
With a relatively small plant and small workforce
Thus, economies of scale are more likely to occur at lower levels of output

12. More Efficient Use of Lumpy Inputs
Another explanation for economies of scale involves the “lumpy” nature of many types of plant and equipment
Some types of inputs cannot be increased in tiny increments, but rather must be increased in large jumps
Plant and equipment must be purchased in large lumps
Low cost per unit is achieved only at high levels of output
Making more efficient use of lumpy inputs will have more impact on LRATC at low levels of output
When these inputs make up a greater proportion of the firm’s total costs
At high levels of output, the impact is smaller

13. Diseconomies of Scale
Long-run average total cost _______ as output increases
As output continues to increase, most firms will reach a point where bigness begins to cause problems
True even in the long run, when the firm is free to increase its plant size as well as its workforce
When long-run total cost rises more than in proportion to output, there are diseconomies of scale
LRATC curve slopes ________________
While economies of scale are more likely at low levels of output
Diseconomies of scale are more likely at higher output levels

14. Constant Returns To Scale
Long-run average total cost is ______ as output increases
When both output and long-run total cost rise by the same proportion, production is characterized by constant returns to scale
LRATC curve is ___
In sum, when we look at the behavior of LRATC, we often expect a pattern like the following
Economies of scale (decreasing LRATC) at relatively low levels of output
Constant returns to scale (constant LRATC) at some intermediate levels of output
Diseconomies of scale (increasing LRATC) at relatively high levels of output
This is why LRATC curves are typically U-shaped

15. Using the Theory: Long Run Costs, Market Structure and Mergers
The number of firms in a market is an important aspect of market structure—a general term for the environment in which trading takes place
What accounts for these differences in the number of sellers in the market?
Shape of the LRATC curve plays an important role in the answer

16. LRATC and the Size of Firms
The output level at which the LRATC first hits bottom is known as the minimum efficient scale (MES) for the firm
Lowest level of output at which it can achieve minimum cost per unit
Can also determine the maximum possible total quantity demanded by using market demand curve
Applying these two curves—the LRATC for the typical firm, and the demand curve for the entire market—to market structure
When the MES is small relative to the maximum potential market
Firms that are relatively small will have a cost advantage over relatively large firms
Market should be populated by many small firms, each producing for only a tiny share of the market

17. LRATC and the Size of Firms
There are significant economies of scale that continue as output increases
Even to the point where a typical firm is supplying the maximum possible quantity demanded
This market will gravitate naturally toward monopoly
In some cases the MES occurs at 25% of the maximum potential market
In this type of market, expect to see a few large competitors
There are significant lumpy inputs that create economies of scale
Until each firm has expanded to produce for a large share of the market

18. Figure 9: How LRATC Helps Explain Market Structure
Dollars
Units per Month 80
$160
100,000
1,000
3,000
LRATCTypical Firm F E
DMarket

19. Figure 9: How LRATC Helps Explain Market Structure
LRATCTypical Firm
Units per Month
100,000 80
$160
Dollars
DMarket

20. Figure 9: How LRATC Helps Explain Market Structure
25,000
Units per Month
100,000 80
$200
Dollars
LRATCTypical Firm H F E
DMarket

21. Figure 9: How LRATC Helps Explain Market Structure
Dollars
Units per Month 80
$160
100,000
1,000
10,000
LRATCTypical Firm E F
DMarket

22. LRATC and the Size of Firms
The MES of the typical firm in this market is 1,000 units
Lowest output level at which it reaches minimum cost per unit
For firms in this market, diseconomies of scale don’t set in until output exceeds 10,000 units
Since both small and large firms can have equally low average costs with neither having any advantage over the other
Firms of varying sizes can coexist

23. The Urge To Merge
If by doubling their output, firms could slide down the LRATC curve in Figure 9, and enjoy a significant cost advantage over any other, still-smaller firm, they would
This is a market that is ripe for a merger wave
A sudden merger wave is usually set off by some change in the market
Market structure in general—and mergers and acquisitions in particular—raise many important issues for public policy
Low-cost production can benefit consumers—if it results in lower prices