Today
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Shifts in MC, ATC, and AVC curves.
Production and cost in the long run.
Shifting the Short Run Cost
Curves of the Firm
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They shift when:
• The price of an input changes.
• There is a change in the level of the fixed inputs
(a change in plant size).
• There is a change in the state of technology
(meaning know-how).
Example: Wages rise
$/Q
MC’
MC
ATC’
ATC
Variable costs rise at all levels of
output. MC shifts up. ATC shifts up.
AVC (not shown) shifts up.
Q
Improvements in Technology
MC
$/Q
MC’
ATC
ATC’
Improvements in technology lead to
lower costs. (Could save only fixed
costs, but usually MC will fall.)
Q
Different Plant Sizes
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Changing the short-run situation of the firm
is best studied in the context of production
and costs in the long-run.
Production and Cost
in the Long Run
Long Run
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The firm’s planning horizon in which it can
choose any combination of inputs. It is not
locked into past decisions in its plans for the
long run.
Firms can “lock-in” to any short-run
situation in the long run.
Choice of Inputs

Goods can be produced using many
different combinations of inputs.
• Examples: cleaning, building a house

How does a firm decide which to use?
• Look at range of available production
techniques for a given level of output.
• Calculate which costs least, given particular
input prices.
Plant size
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Small plants achieve their lowest average
total cost at a low level of output.
Large plants achieve their lowest average
total cost at a high level of output.
In the SR, a firm is stuck with its current
plant size.
In the LR, a firm may choose any plant size
(then it will be stuck at that one for future
SR scenarios).
Average Costs for Various Plant
Sizes
SRAC
3
$/Q
SRAC0
SRAC1
SRAC2
SRAC4
q
In the SR, this firm is using plant size 1. In the LR it
could choose any of these plant sizes.
ATC in the SR and the LR
$/Q
SRAC0
SRAC3
c
SRAC1
f SRAC2
b
SRAC4
e
a
d
qA qB
In the SR, what is its AC of producing qA? qB?
In the LR, what is its AC of producing qA? qB?
q
Long Run Average Cost
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For any level of output, in the long run the
firm will choose the plant size that gives the
lowest possible average cost.
At every q, LRAC  SRAC. (why?)
The LRAC curve is thus the lower envelope
of the SRAC curves.
Long Run ATC
SRAC3
$/Q
SRAC0
SRAC1
SRAC2
SRAC4
LRAC
q
With an Infinite Variety of Plant
Sizes
$/Q
LRAC
q
Economies of Scale
How do you make cars differently if
you plan to produce 100 cars per year
compared to 500,000?
Very Small Auto Plants
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Assembly line too costly, uses too much K.
Use proportionately more labor
Keep fixed costs low
Large Auto Plant
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Assembly line, lots of machines and
automation.
High fixed costs, but spread over lots of
units.
The large plant can get the lowest average
cost if it produces enough units.
Economies of Scale, Continued
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There are Economies of Scale when the LRAC of
making a good falls as output grows.
If you double output, total cost increases by less
than double, average cost falls.
OR—If you double all inputs, you get more than
double the output.
Also called Increasing Returns to Scale.
Downward-sloping portion of LRAC curve.
Examples of EOS
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Almost all products have EOS at low levels of
output. Which ones have EOS even at large levels
of output?
•
•
•
•
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Auto manufacturing
Coal mining
Electricity generation & distribution
Retailing? (Wal-Mart)
If small firms cannot compete against big ones,
probably economies of scale are at work.
Constant Returns to Scale
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You can produce, say, 20% more and your
costs go up 20%.
LRAC stays the same
Sometimes called constant costs.
Horizontal LRAC
You should see firms of different sizes in
the market.
Diseconomies of scale
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Expanding output by 20% will increase costs by,
say, 25%.
LRAC is rising.
Also called Decreasing Returns to Scale or
increasing costs.
Intuition: The firm is so large it is inefficient.
Firms this big will go out of business or scale
down.
The Saucer-Shaped LRAC curve
$/q
LRAC
q0
q1
Between 0 and q0: Economies of Scale
Between q0 & q1: Constant returns to scale
Between q1 and : Diseconomies of Scale
q
Be Sure to Know the Difference
Between:
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Decreasing Returns to Scale: increasing all
inputs by an equal % results in increasing
average costs, and
Diminishing Marginal Returns: holding one
or more important factors constant,
increasing the other factors by equal
increments will eventually result in
decreasing MP (increasing MC).
Shifting LRAC

LRAC will shift any time there is
• a change in input prices
• a change in technology (know-how)

Does the LRAC curve shift when plant size
changes?
Example: Wages fall
$/q
LRAC
LRAC’
q
Why would we expect the downward shift will not be
parallel?
Coming Up
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Begin study of profit maximization in the
context of perfect competition.
Group Work
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Apply economies of scale to movie theaters.
More Screens

The average number of movie screens per
cinema has increased over the last several
years. This seems to suggest there are
increasing returns to scale: that increasing
the number of screens at each location leads
to a lower average cost.
Increasing Returns to Scale at the
Cinema


List several reasons why a firm’s average
costs would fall as the number of screens at
the same location rises.
Hint:
• Comparing a cinema with 1 screen to one with
2 screens, are all costs doubled?
Decreasing Returns to Scale at
the Cinema?
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Even though the average number of screens
per cinema has been rising, cinemas rarely
have 20 or 30 screens each, even in highly
populated, urban areas. This seems to be
evidence that the LRAC for a cinema
eventually turns upward.
List some reasons why a cinema would
have difficulty it were to grow that large.