Costs in the Long Run

1. Costs in the Long Run Important to note the differences from the short run

2. Production in the Long run • All factors of production are variable in the long run • The scale of production: • returns to scale - output/input ratio • constant returns to scale - output/input is constant • increasing returns to scale - output/input is rising • decreasing returns to scale output/input is falling

3. Economies of scale • “Economies of scale exist when the expansion of a firm or industry allows the product to be produced at a lower unit cost … Economies of scale are only possible if there is sufficient demand for the product, eg we would hardly expect to find economies in the production of artificial limbs, because there are simply not enough demanded!”

4. Internal economies of scale • Come about from the growth of the firm regardless of what is happening to other firms

5. Types of internal economies • Technical • Marketing/commercial • Purchasing • Financial/Risk-bearing • Organisational/Human see notes page 5

6. Production in the Long run • Economies of scale - technical • specialisation & division of labour • indivisibilities • principle of multiples • container principle

7. Economies in action

8. External economies of scale • Economies of concentration – specialist suppliers • Economies of information – industries share research • Economies of disintegration – large firms employ smaller firms to carry out processes

9. Production in the Long run Diseconomies of scale • Internal • communication • Management • Higher labour costs – overmanning/overtime Diseconomies of scale • External • Shortage of skilled labour and high wage costs • Shortage of raw materials • Congestion • High rents and property costs

10. Costs in the Long run • Long-run average costs • shape of the LRAC curve

11. Alternative long-run average cost curves Costs LRAC O Output (a) Economies of scale

12. Alternative long-run average cost curves LRAC Costs O Output (b) Diseconomies of scale

13. Alternative long-run average cost curves Costs LRAC O Output (c) Constant costs

14. A typical long-run average cost curve LRAC Costs O Output

15. A typical long-run average cost curve Economies of scale Constant costs Diseconomies of scale LRAC Costs O Output

16. Deriving long-run average cost curves: factories of fixed size SRAC1 Costs 1 factory O Output

17. Deriving long-run average cost curves: factories of fixed size SRAC1 SRAC2 Costs 2 factories O Output

18. Deriving long-run average cost curves: factories of fixed size SRAC1 SRAC3 SRAC2 Costs 3 factories O Output

19. Deriving long-run average cost curves: factories of fixed size SRAC5 SRAC1 SRAC4 SRAC3 SRAC2 5 factories Costs 4 factories O Output

20. Deriving a long-run average cost curve: choice of factory size LRAC Costs O Output

21. Costs • A common topic in the exams! • Know the difference between increasing/diminishing returns and economies of scale • Difference between short run and long run

22. Test your knowledge • Are you a donkey or an elephant?