Economics 111.3 Winter 14 March 12 th, 2014 Lecture 22 Ch. 11:
Output and costs
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Test 3 Friday, March 14 th, 2014 8:30 9:20 Room 200 STM
Chapters to be tested: 9, 10 (up to p. 231) and 11(short-run costs
only) Format: Multiple-Choice Questions (MCQ): 30 questions 100% of
Test mark Time 50 minutes
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Substitution Effect and Income Effect Budget line: P A Q A + P
B Q B = y A B A B Y is unchanged
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A recap:
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MC equals the increase in total cost divided by the increase in
output.
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b) At the current output level, this factory is subject to
diminishing returns. Therefore, the firm is operating along the
upward-sloping portion of its short-run average total cost
curve.
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Study question Consider a firm that experiences constant
marginal returns. For example, the first worker is just as
productive as the second, who is just as productive as the third,
and so on. The same is true for all the firms inputs. Draw the
firms short-run marginal cost curve.
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A typical case:
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An increase in a component of fixed costs shifts TFC, AFC, and
TC upward but AVC, TVC, and MC remain unchanged. An increase in a
component of variable costs shifts TVC, AVC, TC, and MC upward but
AFC and TFC remain unchanged. Shifts in the Cost Curves:
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In the long run, the firm can vary both its use of labour and
of capital. It will vary the use of both factors of production to
maximize profits. As a result, long-run cost will always be less or
equal to short-run cost. Long Run Cost
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2010 Pearson Education Canada
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ATC-1ATC-2 ATC-3 ATC-4 ATC-5 Firm Size & Costs
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ATC-1ATC-2 ATC-3 ATC-4 ATC-5 Firm Size & Costs
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The Long-Run Average Cost Curve The segments of the short-run
average total cost curves along which average total cost is the
lowest make up the long-run average total cost curve. For every
plant capacity size, there is a corresponding short-run ATC curve
It shows the least ATC at which any output can be produced after
the firm has had time to make all appropriate adjustments in its
plant size. LRAC curve is the firms planning curve
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the number of possible plant sizes is virtually unlimited the
number of possible plant sizes is virtually unlimited The Long-run
Cost Curve
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Determinants of the Shape of the Long-Run Cost Curve The law of
diminishing marginal productivity does not hold in the long run
since all inputs are variable. The shape of the long-run cost curve
results from the existence of economies and diseconomies of
scale.
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Economies 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. Economies of Scale are
based on labour specialization managerial specialization efficient
capital other factors, e.g., expected demand or learning by
doing:learning by doing means that as we do something, we learn
what works and what doesnt, and over time we become more proficient
at it
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Economies of Scale and Increasing Returns to Scale Increasing
Returns to Scale occur whenever inputs do not need to be increased
in proportion to the increase in output. Or when a given percentage
increase in all the firms inputs results in the firms output
increasing by a larger percentage.
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Constant Returns to Scale 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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Diseconomies of Scale Diseconomies of scale or decreasing
returns to scale refer to the increasing long run average costs as
output increases. 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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Diseconomies of scale in terms of firms technology are
called
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Summary of Returns to Scale Returns to scaleDoubling 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