1

Long Run Cost

Here we study the long run.

2

Long Run CostsRemember the long run is

when all inputs are variable. I think it is useful to think of

the long run as a connection of many short run periods,

where each short run period has a different amount of the fixed input. Thus in the long

run even the fixed input varies.

3

Long Run

When we have one unit of capital production follows the process we should in the previous two sections. Now let’s imagine we can have two units of capital.

We would have a similar table of numbers and graphs as we did when only one unit of capital was available.

4

Long Run continued

When we switch from one unit of capital to two units, we have the long run because all inputs are then variable.

But with the two units we would have short run curves for that level of capital.

Now we have two sets of cost curves, one for one unit of capital and one for two units of capital.

5

Long run continued

Thus the graph of the long run is really just a bunch of curves, one for each plant size.

I will draw two ATC curves, each with a different amount of capital used.

6

Long Run GraphsATC

Q

ATC1

ATC2

Q1

7

Interpretation

If output is going to be less than Q1

in the long run then only one unit of capital would be wanted because those units would be produced cheapest with one unit of capital.

Greater than Q1 would be produced cheapest with two units of capital.

8

Interpretation

The long run curve is made up from parts of the short run curves. For each range of output the long run curve is the segment of the short run curve that is the lowest, representing the cheapest way to produce that range of output in the long run. On the next slide I show the long run curve smoothed out. But from slide 6 you can see it is not probably smoothed.

9

Smooth long run curveATC

Q

10

Reason for long run shape

The long run cost curve is said the u - shaped(or maybe L shaped), just as in the short run, but for a different reason. In the short run we had diminishing returns. In the long run we have economies of scale.

11

Reason continued

The basic idea of economies of scale is that at least for a while when the plant size is increased the average cost curve is pushed down, implying average costs are lowest in a bigger plant. It may be that further increases in plant size push the average cost curve back up. This would technically be called diseconomies of scale.