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Chapter 8

ECON 208 Chapter 8: ECON 208 Chapter 8
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Department
Economics (Arts)
Course
ECON 208
Professor
Paul Dickinson
Semester
Winter

Description
Producers in the Long Run 8.1 The Long Run: No Fixed Factors In the short run, the only way to adjust output is to adjust the input of the variable factors - in the long run, there are numerous ways to produce any given output Technical Efficiency: when a given number of inputs are combined in such a way as to maximize the level of output --> a firm must choose from a number of technically efficient options to find the one that produces any given output at the lowest cost Profit Maximization and Cost Minimization Cost minimization: an implication of profit maximization that firms choose the production method that produces any given level of output at the lowest possible cost Long run cost minimization • If it possible to substitute one factor for another to keep output constant while reducing total cost, the firm is not minimizing it's cost • Firms should substitute one factor for another factor as long as the marginal product of the one factor per dollar spent on it is greater than the marginal product of the other factor per dollar spent on it Cost minimization: MPk / Pk = MPl / Pl *Whenever the ratio of the marginal product for each factor to its price is not equal for all factors, there are possibilities for factor substitutions that will reduce costs (for a given level of output) *Profit-maximizing firms adjust the quantities of factors they use to the prices of the factors given by the market The Principle of Substitution: the principle that methods of production will change if relative prices of inputs change, with relatively more of the cheaper input and relative less of the more expensive input being used Ex wage goes up = use less labour and more capital 4 examples: • Declines in price of Information and Communications Technology o Banks substitute away from tellers (labour) to ATMs o Explains why methods of production differ around the world • Canada - labour = expensive, farming machinery = cheaper • Developing world - capital is scarce, labour = cheaper o Change type of capital equipment • Airplanes - substitute away from oil to different plane materials o Substitute between capital and electricity • EU - electricity is expensive so they turn off lights/AC when customer leave room (substitution towards a different kind of capital) Long Run Cost Curves Long-run average cost (LRAC): the curve showing the lowest possible cost of producing each level of output when all inputs can be varied *The LRAC is the boundary between cost levels that are attainable (with known technology and given factor prices) and those that are unattainable Saucer-shaped LRAC Curve 1. Decreasing Costs: from zero to Qm (minimum efficient scale), the firm has fall LRACs. An expansion of output permits a reduction of average costs. When LRAC falls as output rises, the has economies of scale. Firm enjoys long-run increasing returns 2. Constant Costs: the firm's long-run average costs fall until output reaches Qm (firm's minimum efficient scale). Firm encounters constant costs over the relevant range of output, meaning that the firm's long-run average costs do not change as output rises - bc factor prices are assumed to be fixed, the firm's output must be increasing exactly in proportion to the increase in input. Constant-cost firm has constant returns 3. Increasing Costs: the LRAC curve is rising - a long-run expansion in production is accompanied by a rise in average costs. If factor prices are constant, the fi
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