Long-Run Costs Copyright ACDC Leadership 2015

2010 Question 19 Copyright ACDC Leadership 2015

Definition of the “Short-Run” We will look at both short-run and long-run production costs. Short-run is NOT a set specific amount of time. The short-run is a period in which at least one resource is fixed. Plant capacity/size is NOT changeable In the long-run ALL resources are variable NO fixed resources Plant capacity/size is changeable Today we will examine LONG-run costs. 3 Copyright ACDC Leadership 2015

Definition and Purpose of the Long Run In the long run all resources are variable. Plant capacity/size can change. Why is this important? The Long-Run is used for planning. Firms use to identify which plant size results in the lowest per unit cost. Ex: Assume a firm is producing 100 bikes with a fixed number of resources (workers, machines, etc.). If this firm decides to DOUBLE the number of resources, what will happen to the number of bikes it can produce? There are only three possible outcomes: Number of bikes will double (constant returns to scale) Bikes will more than double (increasing returns to scale) Bikes will less than double (decreasing returns to scale) Copyright ACDC Leadership 2015

Long Run ATC What happens to the average total costs of a product when a firm increases its plant capacity? Example of various plant sizes: I make looms out of my garage with one saw I rent out building, buy 5 saws, hire 3 workers I rent a factory, buy 20 saws and hire 40 workers I build my own plant and use robots to build looms. I create plants in every major city in the U.S. Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes. 6 Copyright ACDC Leadership 2015

ECONOMIES OF SCALE Why does economies of scale occur? Firms that produce more can better use Mass Production Techniques and Specialization. Example: A car company that makes 50 cars will have a very high average cost per car. A car company that can produce 100,000 cars will have a low average cost per car. Using mass production techniques, like robots, will cause total cost to be higher but the average cost for each car would be significantly lower. 7 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost Costs MC1 ATC1 $9,900,000 $50,000 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 8 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost Economies of Scale- Long Run Average Cost falls because mass production techniques are used. Costs MC1 ATC1 MC2 $9,900,000 ATC2 $50,000 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 9 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost Economies of Scale- Long Run Average Cost falls because mass production techniques are used. Costs MC1 ATC1 MC2 $9,900,000 MC3 ATC2 $50,000 ATC3 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 10 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost Constant Returns to Scale- The long-run average total cost is as low as it can get. Costs MC1 ATC1 MC2 $9,900,000 MC3 MC4 ATC2 $50,000 ATC3 ATC4 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 11 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost Diseconomies of Scale- Long run average costs increase as the firm gets too big and difficult to manage. Costs MC1 ATC1 MC2 $9,900,000 MC5 MC3 ATC5 MC4 ATC2 $50,000 ATC3 ATC4 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 12 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost These are all short run average costs curves. Where is the Long Run Average Cost Curve? Costs MC1 ATC1 MC2 $9,900,000 MC5 MC3 ATC5 MC4 ATC2 $50,000 ATC3 ATC4 $6,000 $3,000 0 1 100 1,000 100,000 1,000,0000 Quantity Cars 13 Copyright ACDC Leadership 2015

Long Run AVERAGE Total Cost Costs Economies of Scale Constant Returns to Scale Diseconomies of Scale Long Run Average Cost Curve 0 1 100 1,000 100,000 1,000,0000 Quantity Cars

Constant Returns to Scale Long Run Average Cost Curve LRATC Simplified The law of diminishing marginal returns doesn’t apply in the long run because there are no FIXED RESOURCES. Costs Economies of Scale Constant Returns to Scale Diseconomies of Scale Long Run Average Cost Curve 15 Copyright ACDC Leadership 2015 Quantity

Unit 3: Costs of Production and Perfect Competition Copyright ACDC Leadership 2015

Candy Markets Simulation 4 Market Structures Candy Markets Simulation Copyright ACDC Leadership 2015

Four Market Structures Market for Operating Systems (Microsoft) Perfect Competition Monopolistic Competition Monopoly Oligopoly Every product is sold in a market that can be considered one of the above market structures. For example: Fast Food Market Cars Manufactures Market for Operating Systems (Microsoft) Strawberry Market Cereal Market Monopolistic Competition (differentiated products) Oligopoly Monopoly Perfect Competition Oligopoly (3 main producers) Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Imperfect Competition Characteristics of Perfect Competition: Examples: Corn, Strawberries, Milk, etc. Many small firms Identical products (perfect substitutes) Low Barriers- Easy for firms to enter and exit the industry Seller has no need to advertise Firms are “Price Takers” The seller has NO control over price. Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Monopoly: Examples: The Electric Company, One large firm (the firm is the market) Unique product (no close substitutes) High Barriers- Firms cannot enter the industry Monopolies are “Price Makers” Copyright ACDC Leadership 2015

Barriers to Entry Types of Barriers to Entry 1. Economies of Scale A monopoly wouldn’t last long if there were not high barriers to keep other firms from entering. Types of Barriers to Entry 1. Economies of Scale Ex: There is only one electric company because they are the only ones that can make electricity at the lowest cost. This is a “natural monopoly” 2. Superior Technology 3. Geography or Ownership of Raw Materials 4. Government Created Barriers The government issues patents to protect inventors and forbids others from using their invention Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Oligopolies: Examples: Cell Phones, Service Providers, Cars A Few Large Producers (Less than 10) Identical or Differentiated Products High Barriers to Entry Control Over Price (Price Maker) Mutual Interdependence Firms must worry about the decisions of their competitors and use strategy Copyright ACDC Leadership 2015

Four Market Structures Perfect Competition Monopolistic Competition Monopoly Oligopoly Characteristics of Mono. Comp: Examples: Fast food, furniture, shoe stores Relatively Large Number of Sellers Differentiated Products Some control over price Low Barriers- easy for firms to enter A lot of non-price competition (Advertising) Copyright ACDC Leadership 2015