ch. 7 Long Run costs

Economies of Scale

(long-run) average cost of production falls as output increases. Ex= If have IRTS, doubling inputs more than doubles output. Since cost doubles and output more than doubles, average cost falls.

Constant Returns to Scale

(long-run) average cost of production is constant as output increases. Ex= Doubling inputs doubles output. Since cost doubles and output doubles, average cost is the same.

Diseconomies of Scale

(long-run) average cost of production rises as output increases. Ex= If have DRTS, doubling inputs less than doubles output. Since cost doubles and output less than doubles, average cost rises.

6) How does the isocost line compare to the budget line?

-both of their slopes are constants that depend on relative prices (linear lines) -w/r =-Pl/Pk vs -Px/Pz -but consumer has single budget line determined by consumer's income and firm has many isocost lines each corresponding to a diff level of expenditures a firm might make, depending on quantity it wants to produce -consumers maximize utility subject to 1 BC vs firms minimize cost of producing q

11) How do changes in prices affect the isocost line & isoquant vs budget line & indifference curves? -BC and IC, price of a good changes--> -Iso and Isoquant, price of input changes-->

-budget was the same with relative price (slope) different, and on new indfference curve -the cost changed, with relative price (slope) different and on same isoquant (bc of no change in tech

13) How is the long-run expansion path related to the long-run cost curve? Long-run average cost?

-firms can calculate cost minimizing output for a given level of output, and repeat this for many output levels to see how cost varies with output -relationship between cost and quantity level help determine the LRAC function

19) What is the shape of the LRAC curve if there are several SRAC curves? If there are many?

-scalloped, solid portions of the several SRAC curves -smooth and u shaped

How to find cost minimizing K and L for certain level of production:

1. Set MRTS = -w/r to find relationship between K and L 2. plug into firm's production constraint, solve for 1 variable 3. plug varialbe into K and L relationship to find 2nd variable

21)What are 3 reasons why LR cost lower than SR cost?

1. flexible inputs: operating at larger scale in LR amy lower LRAC due to increasing returns to scale , no diminishing marginal returns to labor in LR bc K is flexible 2. technical progress: increase in productivity( more output created with same inputs) lowers AC 3. learning by doing : the productive skills and knowledge that workers and mangers gain from experience-->more efficient production over time and cost of goods dec

5) What are the properties of isocost lines? (3)

1. intercepts depend on TC, w, r, aka firms costs and input prices 2. isocosts that are farther rom the origin have higher costs than those closer to the origin 3.the slope of each isocost line = -w/r = (change in K)/change in L = Pl/Pk

7) What are 3 approaches a firm can choose to minimizing cost? Do we get the same result from each of these approaches?

1. lowest isocost rule 2. tangency rule 3. last dollar rule

10) Does the optimal input mix change as r decreases? Does the slope of the isocost curve change as r increases? Does the cost of producing 200 units change as r decreases?

1. yes as r decreases, we use less L, more K 2. yes, slope of isocost is now steeper, -w/r increases as r decreases 3. yes, it became less expensive, cost of producing 200 units falls (difference betwee TC's)

what leads to economies, diseconomies and constant returns to scale

IRTS-->economies DRTS-->diseconomies CRTS-->Constant

22) Does "Learning by Doing" have a different effect on the LRAC curve than Economies of Scale?

Learning by doing shifts LRAC down (all costs decrease) whereas economies of scale results in a downward movement along LRAC curve

20) Which is more costly, expanding output in the SR or LR?, how does EP play into this?

SR, bc LR has more flexibility-->upward sloping expansion path whereas in SR capital is fixed (expansion path is horizontal) -->cheaper to inc Q in LR than SR

15) Why do SRAC curves initially slope down, then up? LRAC?

SRAC: ATC decreases initially bc AFC decreases as it is spread out over more units, and AVC decreases bc MC decreases due to increasing marginal product. Later: ATC increases bc AFC continues dec but AVC increases b more bc MC is increasing due to diminishing marginal product (occurs with fixed inputs) LRAC: economies of scale initially, then constant returns to scale, then diseconomies of scale

k intercept and l intercept are

TC/r TC/w

4) What is the cost of producing a given level of output? TC=

TC=wL + rK

in LR TC=

VC

once a plant becomes a fixed input, SRAC is _________ and LRAC is always _______

at least as high as LRAC -equal to or below SRAC

why is the SREP horizontal

bc K is fixed, you can only increase output by increasing amount of labor

1) When are all inputs variable? Why do firms adjust inputs in the long run?

before the firm constructs the factory

Isocost Line

combination of inputs that require the same total expenditure or cost. At each point along the line, the cost of production is the same.

higher quantities in subsequent periods(increasing cumulative output) will lead to: bc:

decreasing costs per unit bc of learning curve

a store with high AFC will want to _______

downsize

the shape of AC curves deterine whether production process has

economies or disceconomies of scale

a merger results in ____ of scale, bureacracy leads to _______

economies, diseconomies

LRAC is the ___ of SRAC curves

envelope

a store with high AVC will want to ______ and will have economies of scale

expand (like mom and pop convenience store_

flexible inputs

firms can choose from a variety of capital and labor mixes

the cost is ____ along isocost line

fixed at a particular level

In the LR, fixed costs are _____ rather than ___ bc ____-

fixed, sunk, there are no fixed inputs in LR

how does firm determine what quantity to produce at?

look at market size

8) What rule should be used if the isoquant is not smooth or convex (ie, fixed proportions)?

lowest-isocost rule only

Economically Efficient

minimizing the cost of producing a specified amount of output.

LRMC intersects LRAC at its

minimum

do changes in input prices affect the isoquant?

no, bc it only depends on technology or the production function

14) Will LRAC curves always be a straight-line?

no, usually U- shaped for competitive firms where costs rise less than in proporiton to output below q* and then rises more rapidly in proportion to output above q*

technical progress

over time, new technical improvements can lower costs

Tangency Rule

pick the bundle of inputs where the isoquant is tangent to the isocost line aka MRTS aka -MPL/MPK= -w/r

Last dollar rule

pick the bundle of inputs where the last dollar spent on one inputs gives as much extra output as the last dollar spent on any other input.

Lowest Isocost rule

pick the bundle of inputs where the lowest isocost line touches the isoquant.

17) How does a firm pick the size plant/factory it wants to build?

picks to minimize LRAC on the basis of how many units it produces -picks a level of output, then builds plant that minimizes cost for that level of output

18) What happens to average cost once the plant is built?

plant becomes fixed input-->firm can only alter variable inputs

Technoligically Efficient (Efficient Production)

producing the desired level of output with the least amount of inputs.

12) How is the isocost line affected if all input prices increase by the same amount?

relative prices do not change. Slope of isocost does not change, so same tangency point, same combination of L & K -only total cost of isoquant changes

2) What does an isoquant show?

show the many diff technologically efficient combinations of inputs

9) What should a firm do if one of the factor prices changes? Ie, if the price of K falls?

substitute away from now relatively more expensive input L and towards relatively cheaper input k -->isocost line rotates and cost changes

3) Which combination of inputs is also "economically efficient?" What information do we need to know?

the bundle with the lowest cost of production-->need to know input prices

Long-run expansion path

the curve through the tangency points of isocost and isoquant.(The expansion path is unique for each set of input prices). The cost-minimizing combination of labor and capital for each output level.

the slope of the isocost line shows

the rate at which the firm can substitute capital for labor holding TC constant

learning curve

the relationship between average costs and cumulative output

cumulative output

the total number of units of output produced since the product was introduced ( learning is a function of this)

when does a firm have a straight LRAC?

when it has fixed-proportions production

are isocost lines parallel?

yes, bc they are all based on the same relative prices and have same slope