The Cost of Production.PPT

LONG-RUN VERSUS SHORT-RUN COST CURVES 7.4 Long-Run Average Cost ● long-run average cost curve (LAC) Curve relating average cost of production to output when all inputs, including capital, are variable. ● short-run average cost curve (SAC) Curve relating average cost of production to output when level of capital is fixed. ● long-run marginal cost curve (LMC) Curve showing the change in long-run total cost as output is increased incrementally by 1 unit. LONG-RUN VERSUS SHORT-RUN COST CURVES 7.4 Economies and Diseconomies of Scale As output increases, the firm’s average cost of producing that output is likely to decline, at least to a point. This can happen for the following reasons: If the firm operates on a larger scale, workers can specialize in the activities at which they are most productive. Scale can provide flexibility. By varying the combination of inputs utilized to produce the firm’s output, managers can organize the production process more effectively. The firm may be able to acquire some production inputs at lower cost because it is buying them in large quantities and can therefore negotiate better prices. The mix of inputs might change with the scale of the firm’s operation if managers take advantage of lower-cost inputs. LONG-RUN VERSUS SHORT-RUN COST CURVES 7.4 Economies and Diseconomies of Scale At some point, however, it is likely that the average cost of production will begin to increase with output. There are three reasons for this shift: At least in the short run, factory space and machinery may make it more difficult for workers to do their jobs effectively. Managing a larger firm may become more complex and inefficient as the number of tasks increases. The advantages of buying in bulk may have disappeared once certain quantities are reached. At some point, available supplies of key inputs may be limited, pushing their costs up. LONG-RUN VERSUS SHORT-RUN COST CURVES 7.4 Economies and Diseconomies of Scale ● economies of scale Si