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Economics (359)
ECON 101 (172)
Chapter 8

# Chapter 8 - Producers in the Long Run.docx

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School
University of British Columbia
Department
Economics
Course
ECON 101
Professor
Robert Gateman
Semester
Winter

Description
8.1 The Long Run: No Fixed Factors 10-30-2012  All factors can be varied  Numerous ways to produce any given output  Automated machines and few workers vs. simple machines and many workers  Choose type and amount of plant and equipment and size of labour force  Technically efficient – using no more of all inputs than necessary o Not enough for profits to be maximized  Maximize profit by choosing a technically efficient method which produces at the lowest cost (for a desired amount of output)  Profit maximization = cost minimization  Long-run choices – how much K and L to use Profit Maximization and Cost Minimization  Choose the least costly means of producing whatever level of output it chooses Long Run Cost Minimization o Keep output constant while reducing total cost o Substitute one factor for another factor as long as the marginal product of the one factor per dollar spent is greater than the marginal product of the other factor o MPk/Pk = MPl/Pl o Whenever the radio of the marginal product of each factor to its price is not equal for all factors, there are possibilities for factor substitutions that will reduce costs. o Remember! As you substitute away or towards another factor, its marginal factors will change due to the law of diminishing marginal returns (the more of it you use, the less the marginal return). o MPk/MPl = Pk/Pl  Left side: contribution to output of the last unit of capital and labour  Right side: cost of an additional unit of capital compared to the cost of an additional unit of labour  Ex. 2 (left side) = 5 (right side)  last unit of capital is twice as productive but five times more expensive (as the last unit of labour) o Profit maximizing firms adjust the quantities of factors they use to the prices of the factors given by the market. The Principle of Substitution o Methods of production will change if the relative prices of factors change. o Relatively more of the cheaper factor and relatively less of the more expensive factor will be used. o Principle of substitution plays a crucial role in resource allocation o Changes in factor prices are caused by the changing relative scarcities of factors  Firms are motivated to use less of factors that are scarcer (scarce = more expensive) o Explains why methods of producing the same product often differ across countries  Where factor scarcities differ across nations, so will the cost minimizing methods of production. Long Run Cost Curves  When all factors can be varied, there is a minimum achievable cost.  Long run average cost curve – graph of min cost of producing each level of output o Determined by the firm’s current technology and prices of factors o “Boundary” – points below are unattainable, points on curve are attainable o Movement along the LRAC curve – adjustment needed in all factor inputs o The LRAC curve is the boundary between cost levels that are attainable with known technology and given factor prices, and those that are unattainable.  Because all costs are variable in the long run, there is no AVC, AFC, ATC; only one LRAC for any given set of input prices The Shape of the Long-Run Average Cost Curve o First falls, then rises o U-shaped, saucer shaped o Decreasing costs (increasing returns)  constant costs (constant returns)  increasing costs (decreasing returns) o Decreasing cost firm = increasing returns  Expansion of output permits reduction of average costs  Economies of scale  Output is increasing more than in proportion to inputs  Specialization of tasks made possible by the division of labour  Larger plants use greater specialization  Volume of output that the firm sells can justify using the more expensive equipment o Constant cost firm = constant returns  Minimum efficient scale – smallest level of output at which LRAC reaches its minimum; all available economies of scale have been utilized at this point  Flat over some range of output  LRAC does not change  Firm’s output is exactly in proportion to the increase in inputs (constant return) o Increasing cost firm = decreasing returns  LRAC curve is rising  Expansion in production = rise in average costs  Output is increasing less than in proportion to the increase in inputs  Diseconomies of scale  Difficulties managing and controlling an enterprise as its size increases  Management costs per unit will rise  Alienation of the labour force  Difficult to provide appropriate supervision due to more layers of middle managers and supervisors  Managers are likely to pursue their own goals  bonuses and incentives The Relationship between Long-Run and Short-Run Costs o Derived from the same production function o No short-run cost curve can fall below the long-run cost curve because the LRAC curve represents the lowest attainable cost for each possible output. o SRATC curve is one of many such curves, there’s a SRATC for each different plant size o LRAC – envelope curve to a family of SRATC curves tangent to it o Each SRATC curve is tangent to the LRAC curve at the level of output for which the quantity of the fixed factor is optimal and lies above it for all other levels of output (tangent). Shifts in the LRAC Curve  Effects of technological improvement  lower cost methods  shift LRAC curve downwards  If factor prices go down  shift down If factor prices go up  shift up 8.2 The Very Long Run: Changes in Technology 10-30-2012  Changes available in techniques and resour
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