Chapter 8

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University of Toronto Scarborough
Economics for Management Studies
Gordon Cleveland

Chapter 8: Producers in the Long Run 8.1 THE LONG RUN: NO FIXED FACTORS Technical efficiency is when a given number of inputs are combined to maximize the level of output. Profit Maximization and Cost Minimization Cost minimization is 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 Maximization The necessary condition for cost minimization: (MP P K = (KP P ) L L 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. The law of diminishing returns says that, with other inputs held constant, an increase in the amount of one factor used will decrease that factors marginal product. Profit-maximizing firms adjust the quantities of factors they use to the prices of the factors given by the market. The Principle of Substitution This is 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. Long-Run Cost Curves When the minimum cost of producing each level of output is plotted on a graph, the result is called long-run average cost (LRAC) curve.
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