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
