Description
long run cost with the help of graphs. It also explains the concept of economies of scale and diseconomies of scale.
LONG-RUN COSTS
•In the long-run there are no fixed inputs, and therefore no fixed costs. All costs are variable. •Another way to look at the long-run is that in the long-run a firm can choose any amount of fixed costs it wants for making short-run decisions.
The Long-run Average Cost Curve
The long-run average cost curve shows the minimum average cost at each output level when all inputs are variable, that is, when the firm can have any plant size it wants.
There is a relationship between the LRAC curve and the firm's set of short-run average cost curves.
SR and LR Average Costs
• Economists use the term “plant size” to talk about having a particular amount of fixed inputs. Choosing a different amount of plant and equipment (plant size) amounts to choosing an amount of fixed costs. • Economists want you to think of fixed costs as being associated with plant and equipment. Bigger plants have larger fixed costs.
• If each plant size is associated with a different amount of fixed costs, then each plant size for a firm will give us a different set of short-run cost curves. • Choosing a different plant size (a longrun decision) then means moving from one short-run cost curve to another.
• Economists usually assume that plant size is infinitely divisible (variable). In the case of finely divisible plant size, the LRAC curve might look like this:
$/Q
Each small U-shaped curve is a SAC curve.
LRAC
The LRAC curve.
Average costs for a typical firm.
Q
• In the preceding graph, each short-run cost curve corresponds to a particular amount of fixed inputs. • As the fixed input amount increases in the long run, you move to different SR cost curves, each one corresponding to a particular plant size.
• Notice in the graphs of LRAC curves presented so far that the curves have been drawn to be U-shaped. That is, when output is increasing LRAC at first falls, and then eventually rises. • The overall shape of the long-run average cost curve depends on the technology of production.
• For example, advantages implicit in large scale production (with large plants) may allow firms to produce large outputs at lower cost per unit. • On the other hand, firms may get so big that ever increasing managerial and monitoring costs may cause unit costs to rise.
ECONOMIES OF SCALE: When output increases, longrun average costs decline.
$/Q
LRAC shows economies of scale here.
LRAC
Average costs for a typical pizza firm.
Q
DISECONOMIES OF SCALE: When output increases, long-run average costs increase. $/Q
LRAC shows diseconomies of scale here.
LRAC
Average costs for a typical pizza firm.
Q
• For the U-shaped long-run average cost curve, there are economies of scale over small outputs, and diseconomies of scale at larger outputs.
Economies of Scale 1 a. Internal: Real Economies (Production, Marketing, Managerial, Transport and Storage) & Pecuniary Economies 1 b. External Economies
Economies of Scale
• The advantages of large scale production that result in lower unit (average) costs (cost per unit) • AC = TC / Q • Economies of scale – spreads total costs over a greater range of output
Economies of Scale
• Internal – advantages that arise as a result of the growth of the firm
– – – – – Technical Commercial Financial Managerial Risk Bearing
Economies of Scale
• External economies of scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area • Supply of skilled labour • Reputation • Local knowledge and skills • Infrastructure • Training facilities
Capital
Land
Labour
Output
TC
AC
Scale A
Scale B
5
10
3
6
4
8
100
300
•Assume each unit of capital = £5, Land = £8 and Labour = £2 •Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of production facility •What happens and why?
Economies of Scale
Capital Land Labour Output TC AC
Scale A
Scale B
5
10
3
6
4
8
100
300
57
164
0.57
0.54
•Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production •PER UNIT has fallen •Don’t get confused between Total Cost and Average Cost •Overall ‘costs’ will rise but unit costs can fall •Why?
Economies of Scale
• Internal: Technical
– Specialisation – large organisations can employ specialised labour – Indivisibility of plant – machines can’t be broken down to do smaller jobs! – Principle of multiples – firms using more than one machine of different capacities - more efficient – Increased dimensions – bigger containers can reduce average cost
Economies of Scale
• Indivisibility of Plant: • Not viable to produce products like oil, chemicals on small scale – need large amounts of capital • Agriculture – machinery appropriate for large scale work – combines, etc.
Economies of Scale
• Principle of Multiples: • Some production processes need more than one machine • Different capacities may need more than one machine to be fully efficient
• Principle of Multiples: e.g.
Machine A Machine B Machine C Machine D
Capacity = 10 Capacity = 20 per hour per hour
Cost = £100 per machine Cost = £50 per machine
Capacity = 15 Capacity = 30 per hour per hour
Cost = £150 per machine Cost = £200 per machine
Company A = 1 of each machine, output per hour = 10 Total Cost = £500 AC = £50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = £1750 AC = £29.16 per unit
Increased Dimensions: e.g. Transport container = Volume of 20m3
2m 5m
Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 2m £600 per journey AC = £30m3 Total Cost = £1800 per journey AC = £11.25m3
4m 4m 10m
Transport Container 2 = Volume 160m3
Economies of Scale
• Commercial • Large firms can negotiate favourable prices as a result of buying in bulk • Large firms may have advantages in keeping prices higher because of their market power
Economies of Scale
• Financial • Large firms able to negotiate cheaper finance deals • Large firms able to be more flexible about finance – share options, rights issues, etc. • Large firms able to utilise skills of merchant banks to arrange finance
Economies of Scale
• Managerial
– Use of specialists – accountants, marketing, lawyers, production, human resources, etc.
• Risk Bearing
– Diversification – Markets across regions/countries – Product ranges – R&D
Economies of Scale
Minimum Efficient Scale – the point at which the
increase in the scale of production yields no significant unit cost benefits
Minimum Efficient Plant Size – the point where
increasing the scale of production of an individual plant within the industry yields no significant unit cost benefits
Economies of Scale
Unit Cost Scale A 82p Scale B 54p LRAC
MES
Output
Diseconomies of Scale
• The disadvantages of large scale production that can lead to increasing average costs
– Problems of management – Maintaining effective communication – Co-ordinating activities – often across the globe! – De-motivation and alienation of staff – Divorce of ownership and control
doc_434819556.pptx
long run cost with the help of graphs. It also explains the concept of economies of scale and diseconomies of scale.
LONG-RUN COSTS
•In the long-run there are no fixed inputs, and therefore no fixed costs. All costs are variable. •Another way to look at the long-run is that in the long-run a firm can choose any amount of fixed costs it wants for making short-run decisions.
The Long-run Average Cost Curve
The long-run average cost curve shows the minimum average cost at each output level when all inputs are variable, that is, when the firm can have any plant size it wants.
There is a relationship between the LRAC curve and the firm's set of short-run average cost curves.
SR and LR Average Costs
• Economists use the term “plant size” to talk about having a particular amount of fixed inputs. Choosing a different amount of plant and equipment (plant size) amounts to choosing an amount of fixed costs. • Economists want you to think of fixed costs as being associated with plant and equipment. Bigger plants have larger fixed costs.
• If each plant size is associated with a different amount of fixed costs, then each plant size for a firm will give us a different set of short-run cost curves. • Choosing a different plant size (a longrun decision) then means moving from one short-run cost curve to another.
• Economists usually assume that plant size is infinitely divisible (variable). In the case of finely divisible plant size, the LRAC curve might look like this:
$/Q
Each small U-shaped curve is a SAC curve.
LRAC
The LRAC curve.
Average costs for a typical firm.
Q
• In the preceding graph, each short-run cost curve corresponds to a particular amount of fixed inputs. • As the fixed input amount increases in the long run, you move to different SR cost curves, each one corresponding to a particular plant size.
• Notice in the graphs of LRAC curves presented so far that the curves have been drawn to be U-shaped. That is, when output is increasing LRAC at first falls, and then eventually rises. • The overall shape of the long-run average cost curve depends on the technology of production.
• For example, advantages implicit in large scale production (with large plants) may allow firms to produce large outputs at lower cost per unit. • On the other hand, firms may get so big that ever increasing managerial and monitoring costs may cause unit costs to rise.
ECONOMIES OF SCALE: When output increases, longrun average costs decline.
$/Q
LRAC shows economies of scale here.
LRAC
Average costs for a typical pizza firm.
Q
DISECONOMIES OF SCALE: When output increases, long-run average costs increase. $/Q
LRAC shows diseconomies of scale here.
LRAC
Average costs for a typical pizza firm.
Q
• For the U-shaped long-run average cost curve, there are economies of scale over small outputs, and diseconomies of scale at larger outputs.
Economies of Scale 1 a. Internal: Real Economies (Production, Marketing, Managerial, Transport and Storage) & Pecuniary Economies 1 b. External Economies
Economies of Scale
• The advantages of large scale production that result in lower unit (average) costs (cost per unit) • AC = TC / Q • Economies of scale – spreads total costs over a greater range of output
Economies of Scale
• Internal – advantages that arise as a result of the growth of the firm
– – – – – Technical Commercial Financial Managerial Risk Bearing
Economies of Scale
• External economies of scale – the advantages firms can gain as a result of the growth of the industry – normally associated with a particular area • Supply of skilled labour • Reputation • Local knowledge and skills • Infrastructure • Training facilities
Capital
Land
Labour
Output
TC
AC
Scale A
Scale B
5
10
3
6
4
8
100
300
•Assume each unit of capital = £5, Land = £8 and Labour = £2 •Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of production facility •What happens and why?
Economies of Scale
Capital Land Labour Output TC AC
Scale A
Scale B
5
10
3
6
4
8
100
300
57
164
0.57
0.54
•Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production •PER UNIT has fallen •Don’t get confused between Total Cost and Average Cost •Overall ‘costs’ will rise but unit costs can fall •Why?
Economies of Scale
• Internal: Technical
– Specialisation – large organisations can employ specialised labour – Indivisibility of plant – machines can’t be broken down to do smaller jobs! – Principle of multiples – firms using more than one machine of different capacities - more efficient – Increased dimensions – bigger containers can reduce average cost
Economies of Scale
• Indivisibility of Plant: • Not viable to produce products like oil, chemicals on small scale – need large amounts of capital • Agriculture – machinery appropriate for large scale work – combines, etc.
Economies of Scale
• Principle of Multiples: • Some production processes need more than one machine • Different capacities may need more than one machine to be fully efficient
• Principle of Multiples: e.g.
Machine A Machine B Machine C Machine D
Capacity = 10 Capacity = 20 per hour per hour
Cost = £100 per machine Cost = £50 per machine
Capacity = 15 Capacity = 30 per hour per hour
Cost = £150 per machine Cost = £200 per machine
Company A = 1 of each machine, output per hour = 10 Total Cost = £500 AC = £50 per unit Company B = 6 x A, 3 x B, 4 x C, 2 x D – output per hour = 60 Total Cost = £1750 AC = £29.16 per unit
Increased Dimensions: e.g. Transport container = Volume of 20m3
2m 5m
Total Cost: Construction, driver, fuel, maintenance, insurance, road tax = 2m £600 per journey AC = £30m3 Total Cost = £1800 per journey AC = £11.25m3
4m 4m 10m
Transport Container 2 = Volume 160m3
Economies of Scale
• Commercial • Large firms can negotiate favourable prices as a result of buying in bulk • Large firms may have advantages in keeping prices higher because of their market power
Economies of Scale
• Financial • Large firms able to negotiate cheaper finance deals • Large firms able to be more flexible about finance – share options, rights issues, etc. • Large firms able to utilise skills of merchant banks to arrange finance
Economies of Scale
• Managerial
– Use of specialists – accountants, marketing, lawyers, production, human resources, etc.
• Risk Bearing
– Diversification – Markets across regions/countries – Product ranges – R&D
Economies of Scale
Minimum Efficient Scale – the point at which the
increase in the scale of production yields no significant unit cost benefits
Minimum Efficient Plant Size – the point where
increasing the scale of production of an individual plant within the industry yields no significant unit cost benefits
Economies of Scale
Unit Cost Scale A 82p Scale B 54p LRAC
MES
Output
Diseconomies of Scale
• The disadvantages of large scale production that can lead to increasing average costs
– Problems of management – Maintaining effective communication – Co-ordinating activities – often across the globe! – De-motivation and alienation of staff – Divorce of ownership and control
doc_434819556.pptx