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Chapter 8.docx

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McGill University
Economics (Arts)
ECON 208
Sebastien Forte

Chapter 8:  In the long run, all inputs are variable  Firms strive for both technical efficiency and economic efficiency  Technical efficiency relates to trade offs between labour and capital  Economic efficiency relates to output  For any level of output, maximizing profits requires firms to choose their inputs to minimize total costs  Using K and L to represent capital and labour, Pl and Pk as the price for the two factors, cost is minimized when: MP k MP k or MP = k k pk p l MP l pl  When all factors of production can be varied, consider the least-cost method of producing any level of output  The long run average cost curve (LRAC) separates unattainable and attainable cost levels, given technology and factor prices  The LRAC curve is usually U shaped  LRAC curve and ATC curve look alike but are different  Falling LRAC = increasing returns to scale (economies of scale)  Constant LRAC = constant returns to scale  Rising LRAC = decreasing returns to scale (diseconomies of scale)  In the long run, you cannot be worse off in the long run than the short run because things are not fixed  When output exceeds Qm (minimum long run average cost), the firm has rising unit costs. Such an increasing-cost firm is said to encounter decreasing return to scale.  This results from either difficulties in managing and controlling and enterprise as its size increases.  *decreasing returns to scale (LR) is not the same as diminishing marginal returns (SR)  a short run ATC curve cannot fall below the LRAC curve  each short run average total cost curve (SRATC) is tangent to the LRAC curve at the level of output for which the quantity of the fixed factor is optimal  changes in technology and factor prices cause the long run cost curve to shift  A rise in factor prices shifts the LRAC curve upward. A fall in factor prices of a technological improvement shifts the LRAC curve downwards  In the very long run:  Technological change refers to all changes in the available techniques
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