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Chapter 8

ECO100Y1 Chapter 8 & Appendix.docx
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Department
Economics
Course
ECO101H1
Professor
Robert Gazzale
Semester
Winter

Description
ECO100Y1 Textbook Notes Chapter 8 & Appendix 8.1 The Long Run: No Fixed Factors  Firms in the long run must choose the type and amount of plant and equipment and the size of their labour force (must choose between possible short-run cost curves).  Technical efficiency: when a given number of inputs are combined in such a way as to maximize the level of output.  In order to maximize its profit, the firm must choose from among the many technically efficient options the one that produces a given level of output at the lowest cost.  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.  The firm 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.  Only when the ratio of marginal products is exactly equal to the ratio of factor prices is the firm using the cost-minimizing production method.  Profit-maximizing firms adjust the quantities of factors they use to the prices of the factors given by the market.  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.  Where factor scarcities differ across nations, so will the cost-minimizing methods of production.  Long-run average cost (LRAC) curve: the curve showing the lowest possible cot of producing each level of output when all inputs can be varied.  The LRAC curve is determined by the firm’s current technology and by the prices of the factors of production.  The LRAC curve is the boundary between cost levels that are attainable (above), with known technology and given factor prices, and those that are unattainable (below).  The LRAC curve is often “saucer-shaped” and has three portions to it: o Decreasing Costs  Beginning portion where an 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.  The decline in long-run average cost occurs because output is increasing more than in proportion to inputs as the scale of the firm’s production expands.  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.  Increasing returns may occur as a result of increased opportunities for specialization of tasks made possible by the division of labour.  Large specialized equipment is useful only when the volume of output that the firm can sell justifies using that equipment. o Constant Costs  Middle portion where the firm encounters constant costs over the relevant range of output, meaning the firm’s long-un average costs do not change as output changes.  Constant returns (to scale): a situation in which output increases in proportion to inputs as the scale of production is increased. A firm in this situation is a constant-cost firm.  Minimum efficient scale (MES): the smallest output at which LRAC reaches its minimum. All available economies of scale have been realized at this point. o Increasing Costs  End portion where a long-run expansion in production is accompanied by a rise in average costs.  Decreasing returns (to scale): a situation in which output increases less than in proportion to inputs as the scale of a firm’s production increases. A firm in this situation is an increasing-cost firm.  Decreasing returns imply that the firm suffers some diseconomies of scale.  I.e. difficult to control ever-increasing size of
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