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BusinessCosts
GeoffRileyFRSACo-Founderoftutor2u
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ShortRun• Atleastoneofthefactorinputsisfixed(usuallythisiscapitalbutcanalsobeland).Intheshortrun,businessesareconstrainedwithfixed&variablefactors.
LongRun• Allfactorsofproductionarevariableandthescaleofproductioncanalsochangeallowingthefirmtobenefitfromeconomies ofscale
TheShortRunandtheLongRun
Keyevaluationpoint:Thelengthoftheshortrunwillvarybyindustry
TheShortRunandtheLongRun
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TheShortRunandtheLongRunFixedCosts
Fixedcostsdonot vary asthelevelofoutputchangesintheshortrun
Thehighertheleveloffixedcostsinabusiness,thehighermustbetheoutputinordertobreak-even
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TheShortRunandtheLongRunVariableCosts
Variable costsarecoststhatrelatedirectlytotheproductionorsaleofaproduct
Variablecostisdeterminedbythemarginalcostofextraunits ofoutput
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Fixedorvariablecost?Typeyouranswerinthechatwindow!
Workplaceproductivitysoftware
Cloudcomputingservices
Keyevaluationpoint:Advancesindigitaltechnologiesmeanthatmanyfixedcostshavebecomevariablecosts.
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Consultingfees RentalCosts MarketingBudgets
ResearchProjects Fixedsalarycosts Businessinsurance
FixedCosts
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CommissionBonuses WageCosts Componentparts
Basicrawmaterials Energyandfuelcosts Packagingcosts
VariableCosts
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Output TotalCost(£)
AverageTotalCost(£)
MarginalCost(£)
0 2000
50 2500 50 10
100 2700 27 4
150 2850 19 3
200 3000 15 3
250 3250 13 5
300 3900 13 13
350 4550 13 13
400 5600 14 21
MC<AC;ACfalling
MC<AC;ACfalling
MC<AC;ACfalling
MC<AC;ACfalling
MC<AC;ACfalling
MC=AC;ACconstant
MC=AC;ACconstant
MC>AC;ACrising
ChangingMarginalCostasOutputRises
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MC1Cost
Output
AC1
MC2
AC2
Ariseinvariablecostsofproductionleadstoanupwardshiftbothinmarginalandaveragetotalcost
ShowingaRiseinVariableCosts
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EconomiesofScale
LongRunCostsandReturnstoScale
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Internaleconomiesofscale
Expansionofthefirmitself
Lowerlongrunaveragecost(LRAC)asoutputincreases
Externaleconomiesofscale
Expansionoftheindustryofwhichthefirmisamember
Benefitsmost/allfirms
InternalandExternalEconomiesofScale
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InternalorExternalEconomyofScale?Typeyouranswerinthechatwindow!
University ScienceParklowersthecostsof
research
Smallbusinesslowerstheirpurchasingcostsusing agiantwholesaler
ExternalEconomy InternalEconomy
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Q1
AverageCost(UnitCost)
Output
LRAC
Q2 Q3
EconomiesofscalecauseACtofall
LowestpointonLRACisoutputof
productiveefficiency
Economiesofscalearisefromincreasingreturnstoscaleinthelongrun
RisingLRAC– meansdiseconomiesofscale
InternalEconomiesofScale
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Overview:ImpactofScaleEconomiesChange: EconomiesofScale
Output Higher
Profitmaximisingprice Lower
Total profit Higher
Producersurplus Higher
Consumersurplus Higher
Theeffectofscaleeconomiesisanimportantaspecttoconsiderwhenanalysingandevaluatingmarketpower
Overview:ImpactofScaleEconomies
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KeyConcepts– ShortRunCostsAverageCost Totalcostperunitofoutput=Totalcost/
output=TC/Q
AverageFixedCost Totalfixedcostperunitofoutput=TFC/Q
AverageVariableCost Totalvariablecostperunitofoutput=TVC/Q
DiminishingReturns Additionofavariablefactortoafixedfactorresultsinafallinmarginalproduct
FixedCost Businessexpensethatdoesnotvarydirectlywiththelevelofoutput
Marginalcost Thechangeintotalcostsfromincreasingoutputbyoneextraunit
KeyConcepts– ShortRunCosts
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KeyConcepts– LongRunCosts
ConstantreturnstoscaleWhenlongrunaverage cost(LRAC) remainsconstantasoutputincreasesbecauseoutputisrisinginproportionto theinputsused
Diseconomiesofscale Abusinessmayexpandbeyondtheoptimalsizeandsee risingLongRunAverageCost(LRAC)
Economiesofscope Whereitischeapertoproducearangeofproducts–costsavingsfromproductdiversification
ExternaleconomiesofscaleWhenexpansionofanindustryleadstothegrowthofancillaryservicescausingadownwardslopingindustrysupplycurve
IncreasingreturnstoscaleThismeanseconomiesofscale,whenoutputisrisingfasterthaninputswhenallinputscanbevariedinthelongrun
MinimumefficientscaleWhereinternaleconomiesofscalehavebeenfullyexploited.This correspondstothelowestpointonthefirm’slongrunaveragecostcurve (LRAC)
KeyConcepts– LongRunCosts