Production and Costs in the Long

Run

Chapter 6
 Long Run Production Function

A production function Q = f(L, K)

showing the relationship where
between a flow of inputs Q = quantity of output
and the resulting flow of
output, where all inputs L = quantity of labor input
are variable. (variable)
K = quantity of capital input
(variable)

2 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Input Substitution

A managers choice of inputs will be influenced

by:
The technology of the production process
The prices of the inputs of production
The set of incentives facing the given producer

3 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Technology of the Production
Process

Capital-intensive method Labor-intensive method

of production is a of production is a
process that uses large process that uses large
amounts of capital amounts of labor relative
equipment relative to the to the other inputs to
other inputs to produce produce the firms
the firms output. output.

4 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 The Incentives Facing a Given
Producer

The Role of Competitive Environments

Labor Issues
Nonprofit Organizations
Political and Legislative Influences

5 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Long Run Average Cost Function

This is defined as the minimum average or unit

cost of producing any level of output when all
inputs are variable.

6 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Long Run Average Cost Curve

SRAC1
SRAC4
SRAC2
SRAC3 LRAC

Q
7 Copyright 2010 Pearson Education, Inc.
Publishing as Prentice Hall
 Economies and Diseconomies of
Scale
Economies of scale Diseconomies of scale
exist when the firm can exist when the firm
achieve lower unit costs incurs higher unit costs
of production by of production by
adopting a larger scale adopting a larger scale
of production, of production,
represented by the represented by the
downward sloping upward sloping portion
portion of along-run of a long-run average
average cost curve. cost curve.

8 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Economies and Diseconomies of
Scale - Graphical
$

SATC3
SATC1

LRAC
SATC2

Economies of scale Diseconomies of scale

Declining LRAC Increasing LRAC

Q1 Q
9 Copyright 2010 Pearson Education, Inc.
Publishing as Prentice Hall
 Factors Creating Economies of
Scale

Specialization and division of labor

Technological factors
The use of automation devices
Quantity discounts
The spreading of advertising costs
Financial factors

10 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Factors Creating Diseconomies of
Scale

The inefficiencies of managing large-scale

operations.
The increased transportation costs that result
from concentrating production in a small
number of very large plants.

11 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Learning By Doing

The drop in unit costs as total cumulative

production increases because workers become
more efficient as they repeat their assigned
tasks.

12 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Minimum Efficient Scale

That scale of operation $

at which the long-run
average cost curve stops
declining or at which
LRAC
economies of scale are
exhausted.

MES Q
13 Copyright 2010 Pearson Education, Inc.
Publishing as Prentice Hall
 Methods for Determining MES

Surveys of expert opinion (engineering

estimates)
Statistical cost estimation
The survivor approach

14 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Surveying Expert Opionion

Surveying expert opinion is a time-consuming

process that relies on the judgments of those
individuals closely connected with different
industries.
Reporting biases may obviously occur with this
approach.

15 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Statistical Estimation

Researchers attempt to estimate the

relationship between unit costs and output
levels of firms of varying sizes while holding
constant all other factors influencing cost in
addition to size.
This is usually done with multiple regression
analysis.

16 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall
 Survivor Approach

The size distribution of firms is examined to

determine the scale of operation at which most
firms in the industry are concentrated.
The underlying assumption is that this scale of
operation is most efficient and has the lowest
costs because this is where most firms have
survived.

17 Copyright 2010 Pearson Education, Inc.

Publishing as Prentice Hall