Long-Run Costs

optimal scale of plant

scale of plant that minimizes long-run average cost

in equilibrium each firm has SRMC = SRAC = LRAC

short run marginal cost = short run average cost = long run average cost

short run supply curve is part of the marginal cost curve that lies above

average variable cost curve/shut down point

in the long-run firms are free to enter industries or seek profits and leave industries to

avoid losses

for any firm, one of three conditions holds

1. the firm is making positive profits 2. the firm is suffering losses 3. the firm is just breaking even

firms suffering losses fall into two categories

1. those that find it advantageous to shut down operations immediately and bear losses equal to total fixed costs 2. those that continue to operate in the short run to minimize losses

when a firm experiences economies of scale its LRAC will

decline with output

in the graph total revenue is equal to P* x q* (lenght times width) and is the rectangle

P*, A, q*, 0

because we are finding total quantity supplied in industry at each price level, the curves are

added horizontally

increasing returns to scale/economies of scale

an increase in a firm's scale of production leads to lower costs per unit produced

if total revenue exceeds total variable cost, the excess revenue can be used to offset fixed costs and reduce losses,

and it will pay the firm to keep operating

when minmum efficient scale (MES) is large relative to the toal market size we typically expect fewer firms to

be in the industry and competition may be reduced

if total revenue is smaller than total variable cost the firm that operates will suffer losses in excess of fixed cost. the firm can minimize its losses

by shutting down

if input prices are fixed

constant returns imply that average cost of production does not change with scale

in the short run the firm can shut down but it cannot get rid of its fixed costs by

exiting the industry

as price falls the firms excess profit

falls

constant returns to scale means the firms long run average cost curve remains

flat

large firm sizes often entails increased bureaucracy affecting both managerial

incentives and control

if price is less than average variable cost at its lowest point the firm will not only lose its initial investment but also have added

losses on every unit produced

shutdown point

lowest point on average variable cost curve, when price falls below this, total revenue is insufficient to cover variable costs and the firm will shut down and bear losses equal to fixed costs.

in the short run when owners cant leave a business they try to

minimize losses

production function exhibits increasing returns , we mean a given percentage increase in input leads to a LARGER

percentage in the production of output

in long run firms can chose scale of

plant

economies of scale have come from larger firm size rather than gains from

plant size

two things can cause industry supply curve to shift:

short run- decrease in price of input can cause marginal cost curve to shift downward aka supply curve shift outward long run - an increase or decrease in number of firms, in the number of individual firm supply curves shifts the total industry supply curve. new firms enter, supply shifts right, firms exits supply curve moves to the left

firms cut back production so long as the price they receive is less than their

short-run marginal cost

if a firm can lose less than their fixed costs if they continued to operate in the short-run they

should

long-run cost curve

shows the way per unit costs change with output in the long run

once price becomes less than average total costs, in the long-run a firm might decide to

shut down

short run industry supply curve

sum of the marginal cost curves above AVC of all the firms in an industry

firms make no economic profit so that P = SRMC = SRAC = LRAC and there are enough firms so that

supply equals demand

in long run firms can increase any or all of its inputs and thus has no fixed factor of production

that confines its production

breaking even

the firm is earning exactly a normal rate of return, earning a zero level of profit

minimum efficient scale

the smallest size at which long-run average costs is at its minimum

most firms face constant returns to scale at the plant level as long as they can replicate

their existing plants

average total cost = total cost / q so

total cost = average total cost x q

because a firm must bear fixed costs whether or not it shuts down, its decision depends solely on whether total revenue from operating is sufficient to cover

total variable cost

decreasing returns to scale/diseconomies of scale

when an increase in a firms scale of production leads to higher average costs

constant returns to scale

when average costs do not change with the scale of production

long run competitive equilibrium

when entry and exit have moved the industry back into a position of earning normal returns. when P = SMRC = SRAC = LRAC and profits are zero