Review 1 Difference between fixed and variable resources
Review 1. Difference between fixed and variable resources 2. Define and give an example of the law of diminishing marginal returns 3. Identify the three stages of returns 4. Explain why returns are increasing in stage 1 5. Explain why returns are decreasing in stage 2 6. Explain why returns are negative in stage 3 7. Explain how to calculate AVC, AFC, ATC, and MC 8. Explain why the MC curve is J shaped 9. Explain why the ATC curve is U shaped 10. Identify the difference between the short run and the long run 11. Riddle: What is a seven letter word containing 1 thousands of letters?
Long-Run Costs 2
Definition and Purpose of the Long Run In the long run all resources are variable. Plant capacity/size can change. Why is this important? The Long-Run is used for planning. Firms use to identify which plant size results in the lowest per unit cost. Ex: Assume a firm is producing 100 bikes with a fixed number of resources (workers, machines, etc. ). If this firm decides to DOUBLE the number of resources, what will happen to the number of bikes it can produce? There are only three possible outcomes: 1. Number of bikes will double (constant returns to scale) 2. Number of bikes will more than double (economies of scale) 3. Number of bikes will less than double (diseconomies of scale) 3
Long Run ATC What happens to the average total costs of a product when a firm increases its plant capacity? Example of various plant sizes: • I make looms out of my garage with one saw • I rent out building, buy 5 saws, hire 3 workers • I rent a factor, buy 20 saws and hire 40 workers • I build my own plant and use robots to build looms. • I create plants in every major city in the U. S. Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes. 4
ECONOMIES OF SCALE Why does economies of scale occur? • Firms that produce more can better use Mass Production Techniques and Specialization. • For the whole country: Changes in the ‘capital stock’ Example: • A car company that makes 50 cars will have a very high average cost per car. • A car company that can produce 100, 000 cars will have a low average cost per car. • Using mass production techniques, like robots, will cause total cost to be higher but the average cost for each car would be significantly lower. 5
Long Run AVERAGE Total Cost MC 1 Costs ATC 1 $9, 900, 000 $50, 000 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 6
Long Run AVERAGE Total Cost Economies of Scale- AKA Decreasing cost industry. Long MC 1 Run Average Cost falls because ATC 1 mass production techniques are MC 2 used. Costs $9, 900, 000 ATC 2 $50, 000 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 7
Long Run AVERAGE Total Cost Economies of Scale- AKA Decreasing cost industry. Long MC 1 Run Average Cost falls because ATC 1 mass production techniques are MC 2 used. Costs $9, 900, 000 MC 3 ATC 2 $50, 000 ATC 3 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 8
Long Run AVERAGE Total Cost Constant Returns to Scale. AKA Constant Cost industry. The long-run average total cost is as low as it can get. MC 1 Costs ATC 1 MC 2 $9, 900, 000 MC 3 MC 4 ATC 2 $50, 000 ATC 3 ATC 4 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 9
Long Run AVERAGE Total Cost Diseconomies of Scale. AKA Increasing Cost industry. MC 1 Long run average costs increase ATC 1 as the firm gets too big and difficult to manage. MC 2 Costs $9, 900, 000 MC 3 MC 5 MC 4 ATC 5 ATC 2 $50, 000 ATC 3 ATC 4 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 10
Long Run AVERAGE Total Cost MC 1 Costs ATC 1 $9, 900, 000 Diseconomies of Scale- The LRATC is increasing as the firm gets too big and difficult to manage. MC 2 MC 3 MC 5 MC 4 ATC 5 ATC 2 $50, 000 ATC 3 ATC 4 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 11
Long Run AVERAGE Total Cost These are all short run average costs curves. Where is the Long Run Average Cost Curve? MC 1 Costs ATC 1 MC 2 $9, 900, 000 MC 3 MC 5 MC 4 ATC 5 ATC 2 $50, 000 ATC 3 ATC 4 $6, 000 $3, 000 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 12
Long Run AVERAGE Total Costs Economies of Scale Constant Returns to Scale Diseconomies of Scale Long Run Average Cost Curve 0 1 100 1, 000 100, 000 1, 0000 Quantity Cars 13
LRATC Simplified The law of diminishing marginal returns doesn’t apply in the long run because there are no FIXED RESOURCES. Costs Economies of Scale Decreasing Cost Constant Returns to Scale Constant Cost Diseconomies of Scale Increasing Cost Long Run Average Cost Curve Quantity 14
But Why Do costs go up in the long term if Dim. Ret. To Scale doesn’t apply? A: Coordination Problems and Beauracracy Costs Economies of Scale Constant Returns to Scale Diseconomies of Scale Long Run Average Cost Curve Quantity 15
REAL WORLD ECONOMIES OF SCALE 16
17
18
Practice • Draw 3 MC and ATC graphs 1. Draw what happens to curves in the long run if it is an increasing cost industry 2. Draw what happens to curves in the long run if it is an Constant cost industry 3. Draw what happens to curves in the long run if it is an increasing cost industry 4. To The white board! 19
- Slides: 19