ECON 208 Lecture Notes - Lecture 15: Diminishing Returns, Market Structure, Demand Curve

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ECON208Lecture15Chapter8and9
8.1:TheLongRun:NofixedFactors
Inthelongrun,allinputsarevariable
Firmsstriveforbothtechnicalefficiencyandeconomicefficiency
ProfitMaximizationandCostMinimization
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,andpLandpKasthepricefor
thetwofactors,costisminimizedwhen:
ThePrincipleofSubstitution:firmsadjustthequantitiesoffactorsinresponseto
changingrelativefactorprices.
Examplesoftheprinciplesofsubstitutioninaction:
Methodsofproducingthesameproductoftendifferacrosscountries
Airplanesusingmorefuelefficienttechnologies
Theuseofelectricityacrossdifferentcountries
LongRunCostCurves
Whenallfactorsofproductioncanbevaried,considertheleastcostmethod
ofproducinganylevelofoutput.
TheLongRunAverageCost(LRAC)curveseparatesunattainableand
attainablecostlevels,giventechnologyandfactorprices
TheLRACcurveisusuallyUShaped
A“SaucerShaped”LRACCurve
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FallingLRAC→Increasingreturnstoscale
ConstantLRAC→Constantreturnstoscale
RisingLRAC→Decreasingreturnstoscale
WhenoutputexceedsqM,thefirmhasrisingunitcosts.Suchanincreasing
costfirmissaidtoencounterdecreasingreturnstoscale
Thisresultsfromeitherdifficultiesinmanagingandcontrollinganenterprise
asitssizeincreases
*Decreasingreturnstoscale(LR)isnotthesameasdiminishingmarginal
returns(SR)
TheRelationshipbetweenLRACandSRATCCurves
AshortrunATCcurvecannotfallbelowtheLRACcurve
EachSRATCcurveistangenttotheLRACcurveatthelevelofoutputfor
whichthequantityofthefixedfactorisoptimal
ShiftsintheLRACCurve
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