production and cost analysis ii
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Production and Cost Analysis II. Chapter 10. Making Long-Run Production Decisions. To make their long-run decisions, firms look at costs of various inputs and the various production technologies available for combining these inputs, and then decide which combination offers the lowest cost. - PowerPoint PPT PresentationTRANSCRIPT
© 2003 McGraw-Hill Ryerson Limited
Production and Cost Production and Cost Analysis IIAnalysis II
Chapter 10Chapter 10
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Making Long-Run Making Long-Run Production DecisionsProduction Decisions To make their long-run decisions, firms
look at costs of various inputs and the various production technologies available for combining these inputs, and then decide which combination offers the lowest cost.
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Technical Efficiency and Technical Efficiency and Economic EfficiencyEconomic Efficiency Technical efficiency means that the
fewest possible inputs are used to produce a given output.
Technical efficiency is efficiency that does not consider costs of production.
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Technical Efficiency and Technical Efficiency and Economic EfficiencyEconomic Efficiency The economically efficient method of
production is the method that produces a given level of output at the lowest possible cost.
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Determinants of the Determinants of the Shape of the Long-Run Shape of the Long-Run Cost CurveCost Curve The law of diminishing marginal
productivity does not hold in the long run since all inputs are variable.
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Determinants of the Determinants of the Shape of the Long-Run Shape of the Long-Run Cost CurveCost Curve The shape of the long-run cost curve
results from the existence of economies and diseconomies of scale.
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Economies of ScaleEconomies of Scale
There are economies of scale in production when the long run average cost decreases as output increases.
Economies of scale (increasing returns to scale) are cost savings associated with larger scale of production.
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Economies of ScaleEconomies of Scale
An indivisible setup cost is the cost of an indivisible input for which a certain minimum amount of production must be undertaken before the input becomes economically feasible to use.
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Economies of ScaleEconomies of Scale
Indivisible setup costs are the source of many real-world economies of scale.
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Economies of ScaleEconomies of Scale
Economies of scale occur whenever inputs do not need to be increased in proportion to the increase in output.
As output increases, cost per unit falls in the long run, so this can also be seen as an increase in productivity.
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Economies of ScaleEconomies of Scale
Doubling the inputs more than doubles the output, when there are economies of scale.
Firms can economize on management cost, or they can take advantage of specialized labour and specialized capital.
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A Typical Long-Run A Typical Long-Run Average Total Cost Average Total Cost Table, Table, Fig. 10-1a, p 217Fig. 10-1a, p 217
QuantityTotal Costs
of LaborTotal Cost
of MachinesTotal Costs =
TCL + TCM
Average Total Costs = TC/Q
11121314151617181920
$381390402420450480510549600666
$254260268280300320340366400444
$635650670700750800850915
1,0001,110
$58545250505050515356
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Long run average total cost
$64 62 60 58 56 54 52 50 48
11 12 13 14 15 16 17 18 19 20 Quantity
Minimum efficient scale of production
A Typical Long-Run A Typical Long-Run Average Total Cost Average Total Cost Curve, Curve, Fig. 10-1b, p 217Fig. 10-1b, p 217
Economiesof scale
Constant returns to scale
Diseconomiesof scale
Costs per unit
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Economies of ScaleEconomies of Scale
The minimum efficient scale of production is the amount of production that spreads setup costs out sufficiently for firms to undertake production profitably.
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Economies of ScaleEconomies of Scale
The minimum efficient scale of production will be at the beginning of the constant returns portion of the average cost curve—where average total costs are at a minimum.
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Economies of ScaleEconomies of Scale
The implication of economies of scale is that in some industries firms must be of a certain size to be able to compete successfully.
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Diseconomies of ScaleDiseconomies of Scale
Diseconomies of scale or decreasing returns to scale refer to the increasing long run average costs as output increases.
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Diseconomies of ScaleDiseconomies of Scale
Diseconomies occur for a number of reasons as the firm increases its size Coordination of a large firm is more
difficult Information costs and communication
costs increase as firm increases Monitoring costs increase Team spirit may decrease
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Constant Returns to Constant Returns to ScaleScale Constant returns to scale (CRTS) occur
where long-run average total costs do not change as output increases.
It is shown by the flat portion of the long run average total cost curve.
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Summary of Returns to Summary of Returns to Scale,Scale,Table 10-1, p 219Table 10-1, p 219
Returns to scale Doubling inputs results in:
Slope of the LRAC
Increasing returns to scale (IRTS; economies of scale)
Output more than doubles.
downward
Constant returns to scale (CRTS)
Output exactly doubles.
horizontal
Decreasing returns to scale (DRTS; diseconomies of scale)
Output less than doubles.
upward
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Importance of Importance of Economies and Economies and Diseconomies of ScaleDiseconomies of Scale Economies and diseconomies of scale
play important roles in real-world long-run production decisions.
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Importance of Importance of Economies and Economies and Diseconomies of ScaleDiseconomies of Scale The long-run and the short-run average
cost curves have the same U-shape, but the underlying causes of these shapes differ.
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Importance of Importance of Economies and Economies and Diseconomies of ScaleDiseconomies of Scale Economies and diseconomies of scale
account for the shape of the long-run total cost curve.
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Importance of Importance of Economies and Economies and Diseconomies of ScaleDiseconomies of Scale The assumption of initially increasing
and then eventually diminishing marginal productivity (as a variable input is added to a fixed input) accounts for the shape of the short-run cost curve.
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The Envelope The Envelope RelationshipRelationship In the long run all inputs are variable,
while in the short run some inputs are fixed.
As a result, long-run cost will always be less than or equal to short-run cost.
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0 Quantity
SRAC2 SRAC3
SRAC4
LRAC
SRAC1SRMC1
SRMC2
SRMC3
SRMC4
Q2 Q3
Envelope of Short-Run Envelope of Short-Run Average Total Cost Average Total Cost Curves,Curves,Fig.10-2, p 220Fig.10-2, p 220
Q1
Costs per unit
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Economies of ScopeEconomies of Scope
Economies of scope play an important role in firms’ decisions of what combination of goods to produce.
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Economies of ScopeEconomies of Scope
Globalization, by allowing firms to segment the production process, has made economies of scope even more important to firms in their production decisions.
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Production and Cost Production and Cost Analysis IIAnalysis II
End of Chapter 10End of Chapter 10