Producers in the Long Run

3. Increasing Costs: Decreasing Returns

-long-run expansion in production is accompanied with a rise in average costs (ATC; AVC, AFC) If factor prices are constant, the firms' outputs must be increasing less than in proportion to the increase in inputs. When this happens the firms is encountering long-run decreasing returns. diseconomies of scale For output rates greater than qD the firm has rising unit costs. This implies diseconomies of scale (decreasing returns to scale). This typically results from difficulties in managing and controlling an enterprise as its size increases (increasing costs of control).

LRAC QUESTION

The long-run average cost curve is the relationship between the lowest attainable average total cost and output, when plant size is VARIED and labour is VARIED. The long-run average cost curve is made up of the segments of individual average TOTAL cost curves with the lowest average TOTAL cost for a given output.

causes of diseconomies of scale

1. Bureaucratic inefficiencies -organization tougher to manage (time wasted), difficulty managing firm as it gets bigger 2. Principal-agent problem -harder to keep track of employees control of middle-range managers becomes more difficult they may start to persue own goals instead of making profits for the firm

Parts of the LRAC curve

1. Decreasing Costs; Increasing Returns 2. Constant Costs; Constant Returns 3. Increasing Costs; Decreasing Returns

Isoquant Characteristics

1. Downward Sloping -each factor has a positive marginal product 2. Convex when viewed from origin -it takes smaller reductions in capital to compensate for increase in labor

Relationship between long run and short run curves

Each SRATC curve is tangent to LRAC curve at the level of output where quantity of fixed factor is optimal, and lies above it for all other levels of output.

Firms' choices in the very long run

Faced with increases in prices of inputs firms will; substitute away or innovate away from the input or both over different time horizons

Long-Run Cost Minimization

If it is possible to substitute one factor for another to keep output constant while reducing total costs. The firm is not minimizing costs. Firms should, therefore, substitute one factor for another. As long as MP of one per dollar spent is greater then the other Firm is not maximizing when MPk/Pk not equal MPl/Pl K is capital L labor should use more of whichever side of the equation is bigger

Marginal Product of Labor & Capital

If it's not equal, then a firm can lower costs by switching from capital to labour if labour is cheaper and from labour to capital is capital is cheaper

Long-run decreasing returns vs short run diminishing returns

In Short Run - at least one factor is fixed -law of diminishing returns ensures that returns to variable factors will diminish at some point -which drives up MC & ACs In Long Run -all factors are variable -law of diminishing does not apply -if LRAC curve becomes upward sloping it's because of diseconomies of scales not the law

Cost-minimizing production method

MPk/MPl = Pk/PL

Technological Change Types

New Techniques Improved Inputs New Products

2. Constant Costs

Qm - increasing costs the flat part of the curve encounters constant costs over a relevant range of output meaning that kong-run average costs do not change as output rises Because factor prices are assumed tp be fixed, firm output must be be increasing EXACTLY in proportion to the increase in input. When this happens the firm has constant returns

Substitute away

Reduce labor and increase capital is an example

Improved inputs

Steel replacing iron; aluminum substitutes for steel New techniques and improved inputs lead to a reduction in costs and downward shift in LRAC curves

QUESTION

The answer is D ! ATCD indicates the greatest quantity of output

LRAC vs SRAC

When a firm changes its level of production, ATC may rise more in the Short Run than in the Long Run LRAC shows lowest cost of producing any output when all factors are variable SRAC shows lowest cost of producing any output when one or more factors are fixed therefore no srac curve can fall below lrac because the LRAC curve shows the lowest attainable cost for each possible level of output. Each SRATC curve is tangent to the LRAC curve at the level of output for which the quantity of the fixed factor is optimal, and lies above it for all other levels of output.

Least Average Cost Method

When all factors of production can be varied, there exists a least average-cost method of producing any level of output.

1. Decreasing Costs; Increasing Returns

Zero - Qm (Minimum Efficient Scale) Firm has falling long-run average costs ; as ouputs are rising which is increasing returns to scale The decline happens because output is increasing more than in proportion to inputs as the scale of the firm's production expands so returns increase. • Over the range from zero to qM , the firm has falling unit costs. This implies economies of scale (increasing returns to scale). This usually comes from greater specialization as Q increases. •

technological change

a change in the ability of a firm to produce a given level of output with a given quantity of inputs ex: assembly line, robots, fuel efficiency, 3d printing, machine learning and artificial learning (1) TP, AP, and MP curves go UP (PRODUCT GOES UP) (4) TC, ATC, and MC curves down (COSTS GO DOWN)

Isoquant

a curve that shows all the combinations of two inputs, such as capital and labor, that will produce the same level of output Technical efficient combinations of inputs that can produce a given level of output, deals with cost minimization as you move from one point to other; you are substituting for another factor holding output constant

The Very Long Run

a period of time that is long enough for the technological possibilities available to a firm to change

economies of scale

a proportionate saving in costs gained by an increased level of production. an increase in a firm's scale of production leads to lower costs per unit produced as q rises, LRATC falls

cost minimization

an implication of profit maximization that firms choose the production method that produces any given level of output at the lowest possible cost

MPK =

change in Q/Change in K (capital) the increase in output caused by the addition of one more unit of capital. The marginal product of capital diminishes as more and more capital is added

MPL=

change in Q/change in L (labour)

New Product Development

crucial part of steady increase in living standards

LRAC (long run average cost curve)

curve is the boundary between cost levels that are attainable (with given technology and factor prices) and those that are unattainable...

LRAC (long run average cost curve)

curve showing lowest possible cost of producing each level of output when all inputs can be varied boundary between cost levels that are attainable which known technology and given factor prices, and those that are unattainable.

Innovate away

devotes resources to creating new production techniques

constant returns

each additional unit of input is as productive as the previous unit of input

Long-run cost curves are U-shaped because

economies and diseconomies of scale

Productivity

measure of output produced per unit of input used the rate of productivity-increasing means there was a technological change

New Techniques

process innovation; electricity & road building biggest examples -buckets, shovels, horses vs bulldozers, giant trucks

New techniques and improved inputs lead to

reduction in costs and downward shift in LRAC curves

Isocost Lines

shows all combinations of inputs which have the same total cost

Principle of Substitution

states that in response to changes in factor prices, profit-maximizing firms will substitute toward the cheaper factors and substitute away from the more expensive factors.

cost minimization graphically

tangency point between isoquant and isocost lines is the cost-minimizing point

Isoquant Map*

the collection of all isoquants corresponding to a given production function for each level of output

minimum efficient scale (MES)

the lowest level of output at which a firm can minimize the long-run average total cost All possible economies of scale have been realized at this point.

diseconomies of scale

the property whereby long-run average total cost rises as the quantity of output increases

Marginal Rate of Substitution (MRS)

the rate at which a consumer would be willing to trade off one good for another

Marginal Rate of Technical Substitution

the rate at which labor substitutes for capital without affecting output (isoquant)

technically efficient

the set of points in the production set at which the firm is producing as much output as it possibly can given the amount of labor it employs uses no more of all inputs then neccesairly, to not waste valuable inputs. among technical efficient costs profit maximizing firm will chose the one with lowest cost

The Long Run

the time period in which all inputs can be varied; no fixed costs technology is still fixed The ATC curve differs in the Long Run than in the Short Run wheras In the short run, some of the firm's factors of production are fixed. usually physical capital (plant) is fixed, labour is variable

decreasing returns to scale

when long-run average total cost increases as output increases