1. Copyright©2004 South-Western Mod 56 The Costs of Production

2. Copyright © 2004 South-Western/ COSTS IN THE SHORT RUN AND IN THE LONG RUN For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered. In the short run, some costs are fixed. In the long run, fixed costs become variable costs.

3. Copyright © 2004 South-Western/ COSTS IN THE SHORT RUN AND IN THE LONG RUN Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.

4. Average Total Cost in the Short and Long Run Copyright © 2004 South-Western Quantity of Cars per Day 0 Average Total Cost 1,200 $12,000 ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run

5. Copyright © 2004 South-Western/ Economies and Diseconomies of Scale Economies of scale refer to the property whereby long-run average total cost falls as the quantity of output increases. Diseconomies of scale refer to the property whereby long-run average total cost rises as the quantity of output increases. Constant returns to scale refers to the property whereby long-run average total cost stays the same as the quantity of output increases

6. Average Total Cost in the Short and Long Run Copyright © 2004 South-Western Quantity of Cars per Day 0 Average Total Cost 1,200 $12,000 1,000 10,000 Economies of scale ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run Diseconomies of scale Constant returns to scale

7. Copyright © 2004 South-Western/ Economies and Diseconomies of Scale Economies of Scale: the LRATC is falling as the firm expands. Reasons??? Specialization High Set-up Costs Buying Inputs in Bulk Diseconomies of Scale: the LRATC is rising as the firm expands. Reasons??? Problems with Coordination &/or Communication

8. Copyright © 2004 South-Western/ Sunk Costs A sunk cost is a cost that has been incurred in the past and cannot be recovered. Sunk costs don’t matter in decision-making!