economics 2010 lecture 11’ organizing production (ii) production and costs (the long run)
TRANSCRIPT
Economics 2010Economics 2010
Lecture 11’
Organizing Production (II) Production and Costs
(The long run)
Output and CostsOutput and Costs
Plant Size and CostThe Production FunctionDiminishing Returns and Returns to
ScaleShort-Run and Long-Run Cost
Curves
Plant Size and CostPlant Size and Cost
In the short-run, the firm uses a given plant
Short-run costs depend on the firm's short-run production function factor prices
In the long-run, the firm uses the economically-efficient plant size.
Long-run costs depend on: the firm's production function factor prices
Plant Size and CostPlant Size and Cost
The production function is the relationship between the maximum attainable output and the quantity of all the inputs used
The production function is shown by: a table a total product curve for each plant size
The Production FunctionThe Production Function
The Production FunctionThe Production Function
Machines
Labor 1 2 3 4
1
2
3
4
5
4 10 13 15
10 15 18 21
13 18 22 24
15 20 24 26
16 21 25 27
The Production FunctionThe Production Function
Machines
Labor 1 2 3 4
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
The Production FunctionThe Production Function
Machines
Labor 1 2 3 4
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
The Production FunctionThe Production Function
Machines
Labor 1 2 3 4
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
The Production The Production FunctionFunction
Let us plot these production functions
TP1 is the total product curve with 1 machine
TP2 is the total product curve with 2 machines
The Production The Production FunctionFunction
TP3 is the total product curve with 3 machines
TP4 is the total product curve with 4 machines
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Contrast and distinguish between the two related but different concepts of: diminishing marginal returns returns to scale
The law of diminishing returnsWhen a firm has some fixed inputs, if it
increases the quantity of a variable input, the marginal product of the variable input eventually diminishes
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Returns to scaleWhen a firm increases all its inputs by
the same percentage the resulting change in the firms total product is determined by its returns to scale
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Returns to scale can be increasing constant decreasing
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Returns to scale are increasing if: The percentage increase in total product
exceeds the percentage increase in all inputs (eg, if we double the quantity used of all
inputs, the quantity produced more than doubles)
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Returns to scale are constant if: The percentage increase in total product
equals the percentage increase in all inputs
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Returns to scale are decreasing if: The percentage increase in total product is
less than the percentage increase in all inputs
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Machines
Labor 1 2 3 4
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Machines
Labor 1 2 3 4
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Machines
Labor 1 2 3 4
1 4 10 13 15
2 10 15 18 21
3 13 18 22 24
4 15 20 24 26
5 16 21 25 27
Diminishing Returns and Diminishing Returns and Returns to ScaleReturns to Scale
Returns to Returns to ScaleScale
Increasing returns from 1 to 2
Decreasing returns from 2 to 3 and from 3 to 4
26
22
4
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
The long-run average cost (LRAC) curve traces the relationship between the lowest attainable average total cost and output, when both capital and labor inputs can be varied
To see how the LRAC curve is constructed, we begin with some short-run average cost curves
Tom has 4 different plant sizes -- 1, 2, 3, or 4 knitting machines
Each plant has a short-run ATC curve -- just like the ATC curve we've been studying
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
Short-Run Cost CurvesShort-Run Cost Curves
ATC1 is the ATC curve for a plant with 1 knitting machine.
Short-Run Cost CurvesShort-Run Cost Curves
ATC2 is the ATC curve for a plant with 2 knitting machines.
Short-Run Cost CurvesShort-Run Cost Curves
ATC3 is the ATC curve for a plant with 3 knitting machines.
Short-Run Cost CurvesShort-Run Cost Curves
ATC4 is the ATC curve for a plant with 4 knitting machines.
LRAC is made up of the lowest ATC for each level of output.
Therefore, we want to decide which plant has the lowest cost for producing a given level of output
Suppose that Tom wants to produce 13 sweaters a day
Finding the Finding the LRACLRAC Curve Curve
13 sweaters a day cost $7.69 each on ATC1.
Finding the Finding the LRACLRAC Curve Curve
13 sweaters a day cost $6.80 each on ATC2.
Finding the Finding the LRACLRAC Curve Curve
13 sweaters a day cost $7.69 each on ATC3.
Finding the Finding the LRACLRAC Curve Curve
13 sweaters a day cost $9.50 each on ATC4.
Finding the Finding the LRACLRAC Curve Curve
13 sweaters a day cost $6.80 each on ATC2.
Finding the Finding the LRACLRAC Curve Curve
Least-cost way of producing 13 sweaters a day
Finding the Finding the LRACLRAC Curve Curve
18 24
Finding the Finding the LRACLRAC Curve Curve
There is a relationship between the slope of the LRAC curve and returns to scale
When LRAC curve slopes downward, there are increasing returns to scale
In this situation, there are economies of scale
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
When LRAC curve slopes upward, there are decreasing returns to scale
In this situation, there are diseconomies of scale
When the LRAC curve is horizontal, there are constant returns to scale
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
If plant size can be varied by tiny amounts, LRAC curve is a smooth, U-shaped curve
The SRAC curve for each plant just touches the LRAC curve at a single output level
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
Fig. 10.10 shows how SRAC touches LRAC
It also shows economies and diseconomies of scale
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
If the firm produces in the range of economies of scale, it has excess capacity
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves
If the firm produces in the range of diseconomies of scale, it has over-utilized capacity
Short-Run and Long-Run Cost Short-Run and Long-Run Cost CurvesCurves