Production and CostsLong run costs

Short Run Long Run

- Input quantity is fixed for a period of time and cannot be varied. ( include sunk costs)

Types of Costs Through TimeEx. You cant change technology and capital that quickly. 1.) Fixed costs K capital 2.) Variable costsL - labor - Input whose quantity the firm can vary at any time.Ex. Labor can change, you can fire or hire workers.

- All inputs can be varied. - What matters is the scale1.) Everything is variable!

The Production Function Production Function - Amount of outputs that can be produced with a given set of inputsa.) Short run production b.) Long run production c.) Short run costsd.) Long run costs

Long Run CostsWhen a firm changes its plant size, its cost of producing a given output changes.Will the (ATC) average total cost of producing something fall, rise, or remain the same?

Each of these three outcomes arise because when a firm changes its size, it might experience:

Economies of scaleConstant returns to scaleDiseconomies of scale

For an example: I often fly from Shanghai

To Los Angeles

And I have to cross this ocean to get there, so I take a planeThere is a direct flight from Shanghai to LA everyday with about 500 people on average that travel everyday from the two cities

Its easier and cheaper for everyone to go in one big plane

Instead of like 50 small planes

Apple makes products in China for two big reasons

1.) Because labor costs are cheap

Guangzhou and Shenzhen are basically city sized factories.2.) Because the scale of production is so much higher then anywhere else.

Some factories are the size of cities with all the stuff a city has.

Economies of scalewhen a firm increases its inputs and its output increases by a larger percentage and average total cost decreases.

- The main source of economies of scale is greater specialization of both labor and capital.

Inputs by same % TP

By larger % ATCLong Run Costs

Fixed costs Variable costs

For example: You have this factory

Fixed costs Variable costsTotal product

And this factory makes some number of output

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!Then you decide to double your factory and labor size

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!

Bigger! More! We are in the long run bitches!Input same %Input same %Outputhigher %Output increase more then then inputs, you have economies of scale

Constant Returns to scale- when a firm increases its inputs and its output increases by the same percentage and average total cost remains constant.

Inputs by same % TP

By same % ATC

same Long Run Costs

Fixed costs Variable costsTotal product

Same example:

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!Double the size of your factory and labor

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!

Bigger! More! We are in the long run bitches!Input same %Input same %Output same %You get the same output amount then you have constant returns to scale

Diseconomies of scale-when a firm increases its inputs and its output increases by a smaller percentage and average total cost increases.

- Diseconomies of scale arise from the difficulty of coordinating and controlling a large enterprise.

Inputs by same % TP

By smaller % ATCLong Run Costs

Fixed costs Variable costsTotal product

One more time

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!Double your factory and labor size

Fixed costs Variable costsTotal product

Bigger! More! We are in the long run bitches!

Bigger! More! We are in the long run bitches!Input same %Input same %Output lower You get less output then your inputs your having diseconomies of scale:

Lets say the amount of people that fly from PVG to LAX is 1200 and each plane holds 500 people, that third plane with cost you more then you can profit from it and more planes is just more expensive

GMC (Genera Motors of the United States) was the largest car maker in the world

In 2008 the market went way down and the demand for cars decreased a lot

GMC was a huge company for a huge market, but was now too big for the market at the time and suffered diseconomies of scale

In the long run, Both capital and labor inputs can vary.With current firm, ATC = ATC1.With successively larger firms, ATC curves would be ATC2, ATC3, and ATC4.

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The long-run average cost curve, LRAC, traces the lowest attainable average total cost of producing each output.In the long run, Both capital and labor inputs can vary.

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Economies of scale as output increases to 9 gallons an hour constant returns to scale for outputs between 9 gallons and 12 gallons an hour.and diseconomies of scale for outputs that exceed 12 gallons an hour.

*Leave your students with two big ideas:First, a firms long-run production costs depend on the freedom to choose all inputs. Long-run flexibility enables firms to produce at a lower cost than is possible in the short run when some inputs are fixed.Second, in the short run, with one or more fixed inputs, production costs vary with output in a predictable way because they are directly linked to input productivity.

How ATC Changes as the Scale of Production ChangesEconomies of scale: ATC falls as Q increases.

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How ATC Changes as the Scale of Production ChangesEconomies of scale: ATC falls as Q increases. Constant returns to scale: ATC stays the same as Q increases.

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How ATC Changes as the Scale of Production ChangesEconomies of scale: ATC falls as Q increases. Constant returns to scale: ATC stays the same as Q increases.Diseconomies of scale: ATC rises as Q increases.

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LRATC with 3 Firm SizesFirm can choose from 3 factory sizes: S, M, L. Each size has its own SRATC curve. The firm can change to a different factory size in the long run, but not in the short run.

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To produce less than QA, firm will choose size S in the long run. LRATC with 3 Firm Sizes

**The following might be helpful:

After the first paragraph displays, pick a Q a little to the left of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the small factory than the medium one. The firm may be stuck with a medium factory in the short run, but in the long run if it wishes to produce this level of output it will choose the small factory to have the lowest cost per unit. Hence, for Q < QA, the LRATC curve is the portion of ATCS from 0 to QA.

After the second paragraph displays, pick a Q a little to the right of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the medium factory than the small one. The firm may be stuck with a small factory in the short run, but in the long run if it wishes to produce this level of output it will choose the medium factory to have the lowest cost per unit. Hence, for QA < Q < QB, the LRATC curve is the portion of ATCM from QB to QA.

The same type of argument illustrates the logic in the third paragraph.

To produce less than QA, firm will choose size S in the long run.

To produce between QA and QB, firm will choose size M in the long run. LRATC with 3 Firm Sizes

**The following might be helpful:

After the first paragraph displays, pick a Q a little to the left of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the small factory than the medium one. The firm may be stuck with a medium factory in the short run, but in the long run if it wishes to produce this level of output it will choose the small factory to have the lowest cost per unit. Hence, for Q < QA, the LRATC curve is the portion of ATCS from 0 to QA.

After the second paragraph displays, pick a Q a little to the right of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the medium factory than the small one. The firm may be stuck with a small factory in the short run, but in the long run if it wishes to produce this level of output it will choose the medium factory to have the lowest cost per unit. Hence, for QA < Q < QB, the LRATC curve is the portion of ATCM from QB to QA.

The same type of argument illustrates the logic in the third paragraph.

To produce less than QA, firm will choose size S in the long run.

To produce between QA and QB, firm will choose size M in the long run.

To produce more than QB, firm will choose size L in the long run.LRATC with 3 Firm Sizes

**The following might be helpful:

After the first paragraph displays, pick a Q a little to the left of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the small factory than the medium one. The firm may be stuck with a medium factory in the short run, but in the long run if it wishes to produce this level of output it will choose the small factory to have the lowest cost per unit. Hence, for Q < QA, the LRATC curve is the portion of ATCS from 0 to QA.

After the second paragraph displays, pick a Q a little to the right of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the medium factory than the small one. The firm may be stuck with a small factory in the short run, but in the long run if it wishes to produce this level of output it will choose the medium factory to have the lowest cost per unit. Hence, for QA < Q < QB, the LRATC curve is the portion of ATCM from QB to QA.

The same type of argument illustrates the logic in the third paragraph.

In the real world, factories come in many sizes, each with its own SRATC curve. A Typical LRATC Curve

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In the real world, factories come in many sizes, each with its own SRATC curve. So a typical LRATC curve looks like this:A Typical LRATC Curve

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How ATC Changes as the Scale of Production ChangesEconomies of scale: ATC falls as Q increases. Constant returns to scale: ATC stays the same as Q increases.Diseconomies of scale: ATC rises as Q increases.

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Thats the basic idea for now.Bye bye.Thank you

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*Leave your students with two big ideas:First, a firms long-run production costs depend on the freedom to choose all inputs. Long-run flexibility enables firms to produce at a lower cost than is possible in the short run when some inputs are fixed.Second, in the short run, with one or more fixed inputs, production costs vary with output in a predictable way because they are directly linked to input productivity. **

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**The following might be helpful:

After the first paragraph displays, pick a Q a little to the left of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the small factory than the medium one. The firm may be stuck with a medium factory in the short run, but in the long run if it wishes to produce this level of output it will choose the small factory to have the lowest cost per unit. Hence, for Q < QA, the LRATC curve is the portion of ATCS from 0 to QA.

After the second paragraph displays, pick a Q a little to the right of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the medium factory than the small one. The firm may be stuck with a small factory in the short run, but in the long run if it wishes to produce this level of output it will choose the medium factory to have the lowest cost per unit. Hence, for QA < Q < QB, the LRATC curve is the portion of ATCM from QB to QA.

The same type of argument illustrates the logic in the third paragraph. **The following might be helpful:

After the first paragraph displays, pick a Q a little to the left of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the small factory than the medium one. The firm may be stuck with a medium factory in the short run, but in the long run if it wishes to produce this level of output it will choose the small factory to have the lowest cost per unit. Hence, for Q < QA, the LRATC curve is the portion of ATCS from 0 to QA.

After the second paragraph displays, pick a Q a little to the right of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the medium factory than the small one. The firm may be stuck with a small factory in the short run, but in the long run if it wishes to produce this level of output it will choose the medium factory to have the lowest cost per unit. Hence, for QA < Q < QB, the LRATC curve is the portion of ATCM from QB to QA.

The same type of argument illustrates the logic in the third paragraph. **The following might be helpful:

After the first paragraph displays, pick a Q a little to the left of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the small factory than the medium one. The firm may be stuck with a medium factory in the short run, but in the long run if it wishes to produce this level of output it will choose the small factory to have the lowest cost per unit. Hence, for Q < QA, the LRATC curve is the portion of ATCS from 0 to QA.

After the second paragraph displays, pick a Q a little to the right of QA. From this Q, go up to the ATC curves. Notice that cost per unit is lower for the medium factory than the small one. The firm may be stuck with a small factory in the short run, but in the long run if it wishes to produce this level of output it will choose the medium factory to have the lowest cost per unit. Hence, for QA < Q < QB, the LRATC curve is the portion of ATCM from QB to QA.

The same type of argument illustrates the logic in the third paragraph. **

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