Principles of Microeconomics Chapter 7 PDF

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 7 Costs in the Long Run Prepared by Ifeanyi Uzoka, Sheridan College  C...

Principles of Microeconomics SAYRE // MORRIS // GHAYAD Eleventh Edition CHAPTER 7 Costs in the Long Run Prepared by Ifeanyi Uzoka, Sheridan College  CHAPTER 7 Costs in the Long Run Learning Objectives: 1. Distinguish between the short run and the long run 2. Explain why medium-sized firms are sometimes just as efficient as big firms 3. Demonstrate why big firms sometimes enjoy great cost advantages © 2024 McGraw Hill 7-2  CHAPTER 7 Costs in the Long Run Learning Objectives: 4. Demonstrate why firms can sometimes be too big 5. Explain what is meant by the right size of firm. 6. Explain how a change in input prices and technology affects a firm’s costs. 7. Explain why markets can sometimes be too small © 2024 McGraw Hill 7-3  LO1: The Short and Long Run © 2024 McGraw Hill 2-4  The Long Run Long Run – The period of time during which all inputs are variable – A firm can plan as if it is in the long run, but at any one point in time, it operates in the short run Since all production processes operate in the short run, diminishing marginal productivity applies – In the long run, all costs © 2024 are variable and McGraw Hill 7-4  LO2: Constant Returns to Scale © 2024 McGraw Hill 2-6  The Long Run Long Run Average Cost Curve – A graphical representation of the per unit costs of production in the long run A firm can plan as if it is in the long run, but it always operates in the short run. © 2024 McGraw Hill 7-5  The Long Run Constant Returns to Scale – A concept whereby a firm’s output increases by the same percentage as the increase in its inputs – This term, used only in the context of the long run, refers to the situation in which the lowest average cost for each size of plant remains the same. – The result is a horizontal LRAC curve. © 2024 McGraw Hill 7-5 Average Cost of Production in Four Plant Sizes Here, firms that produce at larger scales have the same long run average cost – Connecting the minimum average cost for each plant size gives the long run average cost curve © 2024 McGraw Hill 7-7 Plant Size Alternatives Table 7.2 Rising Sun’s Plant Size Alternatives Output of SIM Cards Plant 2 Plant 3 Plant 4 per Day AC AC AC 100 $10 $20 $40 200 8.00 15.00 26.00 300 6.00 11.00 20.00 400 5.00 8.00 15.00 500 6.00 6.50 12.00 600 8.00 5.00 9.00 700 10.00 6.00 7.00 800 12.00 8.00 5.00 900 15.00 10.00 6.00 1000 21.00 12.00 9.00 © 2024 McGraw Hill 7-8 Test Your Understanding The accompanying table shows the average costs associated with three different plant sizes: – Which Output plantPlant is 1best suited Plant 2 to produce Plant 3 4 Average Cost Average Cost Average Cost units? 1 $45 $62 $80 2 36 47 63 3 42 36 49 4 55 44 36 5 70 68 52 © 2024 McGraw Hill 7-8 Test Your Understanding The accompanying table shows the average costs associated with three different plant sizes: – Which plant is best suited to produce 4 units? Plant 1 Plant 2 Plant 3 Output At 4 units, plant Average Cost 3Average produces Cost at the Average Cost 1 $45 $62 $80 lowest 2 cost36 47 63 3 42 36 49 4 55 44 36 5 70 68 52 © 2024 McGraw Hill 7-8 Test Your Understanding The accompanying table shows the average costs associated with three different plant sizes: – What is the value of long-run average cost? Output Plant 1 Plant 2 Plant 3 Average Cost Average Cost Average Cost 1 $45 $62 $80 2 36 47 63 3 42 36 49 4 55 44 36 5 70 68 52 © 2024 McGraw Hill 7-10 Test Your Understanding The accompanying table shows the average costs associated with three different plant sizes: – What is the value of long-run average cost? Output Plant 1 Plant 2 Plant 3 Average Cost Average Cost Average Cost $361 is the lowest $45 cost for $62 all three$80plants, so 2LRAC = $36 36 47 63 3 42 36 49 4 55 44 36 5 70 68 52 © 2024 McGraw Hill 7-10  LO3: Economies of Scale © 2024 McGraw Hill 2-15  Economies of Scale Economies of Scale: Cost savings a firm can enjoy as a result of large- scale operations – Firms in manufacturing industries are characterized by assembly-line production of standardized products and tend to experience declining long-run average cost © 2024 McGraw Hill 7-12  The LRAC Curve Under Economies of Scale Economies of scale (often referred to as increasing returns to scale) mean that, as the firm grows in size, the minimum average cost of production in each successively bigger plant gets smaller. Here, a firm that produces at a larger scale (2500 instead of 1000) has a lower long run average cost © 2024 McGraw Hill 7-13 Reasons for Economies of Scale © 2024 McGraw Hill 7-14 Test Your Understanding Indicate the presence of either constant returns to scale or increasing returns to scale (economies of scale) in each set of data. Total Cost Output Set 1 $ 30 000 175 60 000 375 Set 2 450 000 100 900 000 200 © 2024 McGraw Hill 7-17 Test Your Understanding Indicate the presence of either constant returns to scale or increasing returns to scale (economies of scale) in each set of Total Cost Output data. Set 1 $ 30 000 175 60 000 375 Set 2 450 000 100 900 000 200 Set 1: Average cost drops from: $30 000 / 175 = $171.43 to $60 000 / 375 = $160 © 2024 McGraw Hill 7-17  Increasing returns to scale Test Your Understanding Indicate the presence of either constant returns to scale or increasing returns to scale (economies of scale) in each set of Total Cost Output data. Set 1 $ 30 000 175 60 000 375 Set 2 450 000 100 900 000 200 Set 2: Average cost remains the same: 450 000 / 100 = $4 500 and 900 000 / 200 = $4 500 © 2024 McGraw Hill 7-17  Constant returns to scale  LO4: Diseconomies of Scale © 2024 McGraw Hill 2-22  Economies of Scale Diseconomies of Scale: Are a result of bureaucratic inefficiencies in management – Average costs of production will increase rather than decrease as size of plant is increased. – Also known as© decreasing 2024 McGraw Hill returns to 7-12  The LRAC Curve Under Diseconomies of Scale LO4 Here, a firm that produces at a larger scale (1600 instead of 1000) has a higher long run average cost © 2024 McGraw Hill 7-21  Reasons for Diseconomies of Scale Increased lines of communication Increased cost of communication Misinterpretation of communication (especially for technical information) Lines of responsibility and decision making becomes blurred © 2024 McGraw Hill 7-14 At a Glance © 2024 McGraw Hill 7-14 Test Your Understanding Decide in each of the following cases whether constant returns, economies, or diseconomies of scale exist. Inputs 1 Inputs 2 Output 1 Output 2 A 6 12 240 480 B 46 92 275 650 C 18 27 500 800 D 260 540 1240 2480 © 2024 McGraw Hill 7-23  Test Your Understanding Decide in each of the following cases whether constant returns, economies, or Inputs 1 Inputs 2 Output 1 Output 2 diseconomies of scale exist. A 6 12 240 480 B 46 92 275 650 C 18 27 500 800 D 260 540 1240 2480 A: Inputs  100%, Output  100%  Constant returns to scale © 2024 McGraw Hill 7-23 B: Inputs  100%, Output  136%  Economies Test Your Understanding Decide in each of the following cases whether constant returns, economies, or Inputs 1 Inputs 2 Output 1 Output 2 diseconomies of scale exist. A 6 12 240 480 B 46 92 275 650 C 18 27 500 800 D 260 540 1240 2480 C: Inputs  50%, Output  60%  Economies of scale © 2024 McGraw Hill 7-23 D: Inputs  108%, Output  100%   LO5: What is the Right Size of Firm? © 2024 McGraw Hill 2-30 The Right Size of a Firm Firms in many industries do not necessarily experience only constant returns to scale, or only economies of scale, or only diseconomies of scale; in fact, for the majority of firms, all three may be present over different output ranges. © 2024 McGraw Hill 7-28 The Right Size of a Firm Economies of scale usually exist up to a point Then constant returns set in Eventually diseconomies set in © 2024 McGraw Hill 7-28  Three Possible LRAC Curves Different industries have different economies of scale available Examples Automobile Computer software Vegetable farming production Cable TV Real estate services Dollar stores distribution © 2024 McGraw Hill 7-29 The Right Size of a Firm A firm can be considered to be of the right size only if it is big enough to capture economies of scale but not so big as to suffer diseconomies. The right size is called the Minimum Efficient Scale (MES). © 2024 McGraw Hill 7-28  Minimum Efficient Scale Minimum Efficient Scale – the smallest size plant capable of achieving the lowest long-run average cost © 2024 McGraw Hill 7-28  LO6: Changes in Short and Long- Run Costs © 2024 McGraw Hill 2-36  Changes in Short Run and Long Run Costs Both short-run and long-run average costs can decrease if the price of factor inputs decreases technological improvement occurs mergers reduce the average fixed costs of the new firm © 2024 McGraw Hill 7-27  Changes in Short Run and Long Run Costs A drop in input prices or the introduction of an improved technology will shift the cost curves of every possible plant size and thus shift down the long-run © 2024 McGraw Hill 7-21 average  LO7: Can a Market Be Too Small? © 2024 McGraw Hill 2-39  Can a Market Be Too Small? Yes, a market can be too small if it limits the size of the firm to an output level that is – below economic capacity in the short run – below minimum efficient scale in the © 2024 McGraw Hill 7-30  Can a Market Be Too Small? Minimum Efficient Scale (MES) – If a small market limits the firm’s output to Q1, then its average cost (AC1) is not able to achieve minimum efficient scale Plant 2 achieves the minimum efficient scale © 2024 McGraw Hill 7-30  CHAPTER 7 Key Concepts to Remember 1. Firms always operate in the short run, but can plan as if they are in the long run 2. The conditions for economies, constant returns, and diseconomies of scale, and how they relate to costs © 2024 McGraw Hill 7-42  CHAPTER 7 Key Concepts to Remember 3. The impact of technological change on costs 4. The best size of a firm will depend on the industry 5. Some markets may be too small to produce efficiently © 2024 McGraw Hill 7-43