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Chapter 8

Chapter 8- Producers in the Long Run.docx

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Kalina Staub

Chapter 8- Producers in the Long Run 8.1- The Long Run: No Fixed Factors  When all factors can be varied, there are numerous ways to produce any given output  Firms can choose type and amount of plant and equipment and size of labour force  Technically Efficient- When a given number of inputs are combined in such a way as to maximize the level of output; using no more of all inputs than necessary 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  Not minimizing costs is when it’s possible to substitute one factor for another to keep output constant while reducing total cost o Firm should substitute one factor for another factor as long as the marginal product of the one factor per dollar spent on it > the marginal product of the other factor per dollar spent on it (not minimizing costs when two are not equal)  Necessary condition for cost minimization is then MPk/Pk (capital) = MPL = PL (labour) o If MPk/Pk < MPL = PL, then employ less capital and more labour o If MPk/Pk > MPL = PL, then employ more capital and less labour  Whenever the ratio 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 (for a given level of output)  MPx/MPL=Pk/PL o Right side shows how the cost of an additional unit of capital compares to the cost of an additional unit of labour o Left side compares the contribution to output of the last unit of capital and the last unit of labour o If both sides are the same, then the firm cannot make any substitutions between labour and capital to reduce costs (if output is held constant)  Profit maximizing firms adjust the quantities of factors they use to the prices of the factors given by the market  The Principle of Substitution  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 relatively less of the more expensive input being used  Methods of production will change if the relative prices of factors change; relatively more of the cheaper factor and relatively less of the more expensive factor will be used  Play central role in resource allocation because it relates to the way in which individual firms respond to changes in relative factor prices that are caused by the changing relative scarcities of factors in the economy as a whole; motivated to use less of factors that are scarce and more of factors that are plentiful Long Run Cost Curves  Long Run Average Cost Curve (LRAC)- The curve showing the lowest possible cost of producing each level of output when all inputs can be varied  The LRAC curve is the boundary between cost levels that are attainable, with known technology and given factor prices, and those that are unattainable  The Shape of the Long Run Average Cost Curve- “Saucer Shaped” has three portions: 1. Decreasing Costs  Falling LRAC: expansion of output permits a reduction of average costs  Economies of Scale- Reduction of long run average costs resulting from an expansion in the scale of a firm’s operations so that more of all inputs is being used  Increasing Returns (to scale)- A situation in which output increases more than in proportion to inputs as the scale of a firm’s production increases; a firm in this situation is a decreasing cost firm o Occur as a result of increased opportunities for specialization of tasks made possible by the division of labour o Large specialized equipment is useful only when the volume of output that the firm can sell justifies using that equipment 2. Constant Costs  Minimum Efficient Scale- The smalle
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