Long Run Cost and Economies of Scale. Long run average total cost curve (LRATCC) ▫Shows the relationship between output and average total cost when fixed.

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Presentation transcript:

Long Run Cost and Economies of Scale

Long run average total cost curve (LRATCC) ▫Shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output. ▫If there are many possible choices of fixed cost the long-run average total cost curve will have the U- shape.

▫Distinction between long and short run  In the long run a producer has had time to choose the fixed cost appropriate for its desired level of output, the producer will be at some point on the long-run average total cost curve.  If output level is altered, the firm will no longer be on the LRATCC and will instead be moving along its current short run average total cost curve.  It will not be on LRATCC until it readjusts its fixed costs for its new output level.

Returns to scale ▫What gives the LRATCC its shape?  It is the influence of scale (the size of a firm’s operations) on its long-run average total cost of production.  Firms that experience scale effects in production find that their long-run average total cost changes substantially depending on the quantity of output they produce.

▫Economies of Scale  When long-run average total cost declines as output increases

 Increasing returns to scale  When output increase more than in proportion to an increase in all inputs  Diseconomies of scale  When long-run average total cost increases as output increase.

 Decreasing returns to scale  When output increases less than in proportion to an increase in all inputs  Constant returns of scale  When output increases directly in proportion to an increase in all inputs.

Sunk Costs ▫When making decisions knowing what to ignore is important. ▫Sunk costs are costs that have already been incurred and are nonrecoverable. ▫They should be ignored in a decision about future actions.