Chapter 8 Reading Notes
• in the long run, there are numerous ways to produce any given output. Thus, firms in the long run must
choose the type and amount of plant and equipment and the size of their labour force
• in making these choices, the firm will try to be technically efficient, which means using no more of all
inputs necessary - that is the firm dows not want to waste any of its valuable inputs.
• cost minimization is to select the production method that produces its output at the lowest possible cost.
• the necessary condition for cost minimization:
o let K = capital. L=labour. pL and pK = price of labour/capital.
o mpK/pK=mpL/pL OR. mpK/mpL=pK/pL
o whenever the ratio of the marginal product of each factor to its price is not equal for all factors,
there are possiblities for factor substitutions that will reduce costs (for a given level of output)
o if the two sides are equal then the firm can't make substitutions between labour and capital to
reduce costs. (if output is held constant). Only when it is equal that you can use the cost
• profit maximizing firms adjust the quantities of factors they use to the prices of the factors givne by the
The principle of substitution
• the principle that methods of production will change if relative prices of inpupts 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.
• this principle plays acentral 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.
Long Run cost Curves
• LRAC - long run average cost curve - the curve showing the lowest possible cost of producing each
level of output when all inputs can be varied.
• this curve is determined by the firm's current technology and by the prices of the factors of production.
It is a "boundary" in the sense that points below it are unattainable; points on the curve or above are
attainable if sufficient time elapses for all inputs to be adjusted.
• To move from one point to another on the LRAC curve requires an adjustment in all factor inputs.
• for this curve, there are no fixed factors of production. Since all costs are variable in the long run, we
don't need to distinguish among AVC, AFC, ATC. In the long run, there is only one LRAC for any given
set of input prices. • when LRAC falls as output rises, the firm is said to have economies of scale. Which is the reduction of
LRAC resulting from an expansion in the scale of a firm's operatio