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CHAPTER 7

Cost Theory and Estimation

CHAPTER OUTLINE

7-1

The Nature of Costs

7-2

Short-Run Cost Functions • Short-Run Total and Per-Unit Cost Functions • Short-Run Total and Per-Unit Cost Curves

7-3

Long-Run Cost Curves • Long-Run Total Cost Curves • Long-Run Average and Marginal

Cost Curves • Case Study 7-1: The Long-Run Average Cost Curve in Electricity Generation

7-4 Plant Size and Economies of Scale • Case Study 7-2: The Shape of the Long-Run Average

7-5

Cost Curve Learning Curves • Case Study 7-3: To Reduce Costs, Firms Often Look Far Afield

7-6

Minimizing Costs Internationally-The New Economies of Scale • International

Trade in Inputs • Case Study 7-4: The IBM PC and the Boeing 777 and 787 Are All but

American!

The New International Economies of Scale • Immigration of Skilled Labor

7-7

Logistics or Supply-Chain Management • Case Study 7-5: Logistics at National

Semiconductors,

Saturn, and Compaq

7-8

Cost-Volume-Profit Analysis and Operating Leverage • Cost-Volume-Profit Analysis

• Operating Leverage • Case Study 7-6: Breakeven Analysis for Tata Motor's Nano Car

7-9

Empirical Estimation of Cost Functions • Data and Measurement Problems in Estimating Short-Run Cost Functions • The Functional Form of Short-Run Cost Functions • CaseStudy 7-7:

Estimates of Short-Run and Long-Run Cost Functions • Estimating Long-Run Cost Functions

with Cross-Sectional Regression Analysis • Estimating Long-Run Cost Functions with Engineering and Survival Techniques

Summary • Problems

Appendix to Chapter 7: Cost Analysis with Calculus • Appendix Problems

Supplementary Readings • Internet Site Addresses

262

CHAPTER7 Cost Theory and Estimation

263

KEY TERMS (in the order of their appearance)

ExpLicit costs Implicit costs ALternative or opportunity costs Economic costs Accounting costs ReLevant cost IncrementaL cost Sunk costs TotaLfixed costs (TFC) TotaLvariabLe costs (TVC) TotaLcosts (TC) Average fixed cost (AFC)

Average variabLe cost (AVC) Average totaL cost (ATC) MarginaL cost (MC) Long-run totaL cost (LTC) Long-run average cost (LAC) Long-run marginaL cost (LMC) PLanning horizon Economies of scope Learning curve Foreign sourcing of inputs New internationaL economies of scaLe

Brain drain Logistics Cost-voLume-profit or breakeven

anaLysis Contribution margin per unit Japanese cost-management system Operating Leverage Degree of operating Leverage (DOL)

Engineering technique SurvivaL technique

W e saw in Section 1-2 that the aim of a firm is generally to maximize profits. Total

profits equal the positive difference between total revenue and total costs. The total

revenue of the firm was examined in Part Two of the text, which dealt with demand

analysis. In this chapter we examine costs and their importance in decision making. The firm's cost functions are derived from the optimal input combinations examined in the pre- ceding chapter and show the minimum cost of producing various levels of output. Clearly, cost is an important consideration in managerial decision making, and cost analysis is an essential and major aspect of managerial economics.

The

chapter begins by examining the nature of costs of production. These include

explicit and implicit costs, relevant or opportunity costs, and incremental costs. We then de- rive the firm's short-run and long-run total, average, and marginal cost curves. After that, we examine plant size and economies of scale, economies of scope, and the learning curve. Subsequently, we discuss international trade in inputs and the immigration of skilled labor, as well as logistics or supply chain management. Finally, we discuss breakeven analysis and examine the empirical estimation of cost functions.

7-1

THE NATURE OF COSTS

One crucial distinction in the analysis of costs is between explicit and implicit costs. Explicit costs refer to the actual expenditures of the firm to hire, rent, or purchase the inputs

it requires in production. These

include the wages to hire labor, the rental price of capital,

equipment, and buildings, and the purchase price of raw materials and semifinished prod-

ucts. Implicit costs production activity.

refer to the value of the inputs owned and used by the firm in its own

Even though the firm does not incur any actual expenses to use these

inputs, they are not free, since the firm could sell or rent them out to other firms. The

amount for which the firm could sell or rent out these owned inputs to other firms repre- sents a cost of production of the firm owning and using them. Implicit costs include the highest salary that the entrepreneur could earn in his or her best alternative employment

  • 264 PARTTHREE Production and Cost Analysis

(say, in managing another firm), and the highest return that the firm could receive from

investing its capital in the most rewarding alternative use or renting its land

and buildings

to the highest bidder (rather than using them itself). In economics, both explicit and implicit costs must be considered. That is, in measur- ing production costs, the firm must include the alternative or opportunity costs of all in- puts, whether purchased or owned by the firm. The reason is that the firm could not retain a hired input if it paid a lower price for the input than another firm. Similarly, it would not

pay for a firm to use an owned input if the value (productivity) of the input is greater to an- other firm. These economic costs must be distinguished from accounting costs, which

refer only to the firm's actual expenditures

or explicit costs incurred for purchased or

rented inputs. Accounting or historical costs are important for financial reporting by the

firm and for tax purposes. For managerial decision-making purposes (with

which we are

primarily interested here), concept that must be used.

however, economic or opportunity costs are the relevant cost Two examples will clarify this distinction and will highlight its

importance in arriving at correct managerial decisions. One example is from inventory valuation. Suppose that a firm purchased a raw mate- rial for $100, but its price subsequently fell to $60. The accountant would continue to re- port the cost of the raw material at its historical price of $100. The economist, however, would value the raw material at its current or replacement value. Failure to do so might lead to the wrong managerial decision. This would occur if the firm decided not to produce a

commodity that would lead to a loss if the raw material were valued at its historical cost

of

$100 but to a profit if the raw material were valued

at its current or replacement value

of

$60. The fact that the firm paid $100 for the input is irrelevant to its current production

decision since the firm could only obtain $60 if it sold the input

now. The $40 reduction in

the price of the raw material is a sunk cost that the firm should not consider in its current managerial decisions.

Another example is given by the measurement of depreciation

cost for a long-lived

asset. Suppose that a firm purchased a machine for $1,000. If the estimated life of the

machine is 10 years and the accountant uses a straight-line depreciation method (that

is, $100 per year), the accounting value of the machine is zero at the end of the tenth

year. Suppose, however, that the machine

can still be used for (i.e., it would last) another

year and that the firm could sell the machine for $120 at the end of the tenth year or use it

for another year. The cost of using the machine is zero as far as the accountant is concerned (since the machine has already been fully' depreciated), but it is $120 for the economist. Again, incorrectly assigning a zero cost to the use of the machine would be wrong from an economics point of view and could lead to wrong managerial decisions. In discussing production costs, we must also distinguish between marginal cost and incremental cost. Marginal cost refers to the change in total cost for a l-unit change in out-

put. For

example, if total cost is $140 to produce 10 units of output and $150 to produce

11 units

of output, the marginal cost of the eleventh unit is $10. Incremental

cost, on the

other hand, is a broader concept and refers to the change in total costs from implementing

a particular management decision, such as the introduction of a new product line, the un- dertaking of a new advertising campaign, or the production of a previously purchased component. The costs that are not affected by the decision are irrelevant and are called sunk costs.

[ 7-2

CHAPTER7 Cost Theory and Estimation

265

SHORT-RUN COST FUNCTIONS

In this section we distinguish between fixed and variable costs and derive the firm's total and per-unit cost functions. These cost functions are derived from input prices and the op- timal input combinations used to produce various levels of outputs (as explained in the previous chapter).

Short-Run Total and Per-Unit Cost Functions

In Section 6-1 we defined the hart run as the time period during which some of the firm's inputs are fixed (i.e., cannot be readily changed, except perhaps at great expense). The total obligations of the firm per time period for all fixed inputs are called total fixed costs (TFC). These include interest payments on borrowed capital, rental expenditures on leased plant and equipment (or depreciation associated with the passage of time on owned plant and equipment), property taxes, and those salaries (such as for top management) that are fixed by contract and must be paid over the life of the contract whether the firm produces

or not. Total variable costs (TVC), on the other hand,

are the total obligations of the firm

per time period for all the variable inputs that the firm uses. Variable input are those that

the firm can vary easily and on short notice. Included in variable costs are payments for raw materials, fuels, depreciation associated with the use of the plant and equipment, most labor costs, excise taxes, etc. I Total costs (TC) equal total fixed costs (TFC) plus total vari- able costs (TVC). That is,

TC= TFC+ TVC

[7-1]

Within the limits imposed by the given plant and equipment, the firm can vary its output in the short run by varying the quantity used of the variable inputs. This gives rise to the TFC, TVC, and TC functions of the firm. These show, respectively, the minimum fixed, variable, and total costs of the firm to produce various levels of output in the short run. Cost functions show the minimum costs of producing various levels of output on the assumption that the firm uses the optimal or least-cost input combinations to produce each level of output. Thus, the total cost of producing a particular level of output is ob- tained by multiplying the optimal quantity of each input used times the input price and then adding all these costs. In defining cost functions, all inputs are valued at their op- portunity cost, which includes both explicit and implicit costs. Input prices are assumed to remain constant regardless of the quantity demanded of each input by the firm. From the total fixed, total variable, and total cost functions, we can derive the corre- sponding per-unit (average fixed, average variable, average total, and marginal) cost func- tions of the firm. Average fixed cost (AFC) equals total fixed costs (TFC) divided by the

I In incremental-cost analysis, semivariable costs are often encountered. These are cost changes that arise if out- put falls outside some speci fied range. For example, by contract the firm may be able to reduce the salary of top management if output falls sharply or must pay bonuses for large increases in output.

  • 266 PARTTHREE Production and Cost Analysis

level of output (Q). Average variable cost (AVC) equals total variable costs (IVC) divided by output. Average total cost (ATC) equals total costs (TC) divided by output. Average total cost also equals average fixed cost plus average variable cost. Finally, marginal cost (MC) is the change in total costs or the change in total variable costs (IVC) per unit change in output.i That is,

AFC = TFC

 
 

Q

AVC= IVC

 
 

Q

TC

ATC

= -

= AFC+ AVC

Q

MC

= llTC = llIVC

llQ

llQ

[7 -2]

[7-3]

[7-4]

[7-5]

Short-Run Total and Per-Unit Cost Curves

Table 7-1 shows the hypothetical short-run total and per-unit cost schedules of a firm.

These schedules are plotted

in Figure 7-1. From column 2 of Table 7-1 we see that TFC are

$60 regardless of the level of output. IVC (column 3) are zero when output is zero and

rise

as output rises. Up to point G' (the point of inflection in the top panel of Figure 7-1),

the firm uses little of the variable inputs with the fixed inputs and the law of diminishing

 

Short-Run Total and Per-Unit Cost Schedules

 

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

Quantity

Total

Total

Total

Average

Average

Average

Marginal

of Output

Fixed Costs

Variable Costs

Costs

Fixed Cost

Variable Cost

Total Cost

Cost

  • 0 $

$60

0

$ 60

  • 1 60

20

80

$60

$20

$80

$20

  • 2 60

30

90

30

15

45

10

  • 3 60

45

105

20

15

35

15

  • 4 60

80

140

15

20

35

35

  • 5 60

135

195

12

27

39

55

2 Since the difference between TC and TVC is TFC, which are fixed, the change in TC and the change in TVC per unit change in output (MC) are identical. In terms of calculus,

MC = d(TC) = d(TVC)

dQ

dQ

since

d(TFC) = 0 dQ

CHAPTER 7 Cost Theory and Estimation

267

Costs ($) TC 200 Total 180 fixed costs 160 140 120 100 Total 80 variable costs
Costs ($)
TC
200
Total
180
fixed
costs
160
140
120
100
Total
80
variable
costs
60
Total
40
fixed
costs
20
o
Output (Q)
o
1
2
3
4
5
Perunit
costs ($)
80
70
60
50
ATC
40
Ave
30
20
10
o
Output (Q)
o
1
1.5
2
2.5
3
3.5
4
5

FIGURE 7-1

Short-Run Total and Per-Unit Cost Curves

The top panel shows that TVC is zero when

output is zero and rises as output rises. At point G' the law of diminishing returns begins to operate. The

TC curve has the same shape as the TVC curve and is above it

by $60 (the TFC). The bottom panel shows

U-shaped AVC, ATC, and MC curves. AFC =ATC - AVC and declines continuously as output rises. The MC curve reaches a minimum before the AVC and ATC curves and intercepts them from below at their lowest

points.

  • 268 PARTTHREE Production and Cost Analysis

returns is not operating. Thus, the TVC curve faces downward or rises at a decreasing rate.

Past point G' (i.e., for output levels greater

than 1.5 units in the top panel of Figure 7-1), the

law of diminishing returns operates, and the TVC curve faces upward or rises at an in-

creasing rate. Since TC = TFC + TVC, the TC curve has the same shape as the TVC curve

but is $60 (the amount ofthe TFC) above

it at each output level. These TVC and TC sched-

ules are plotted in the top panel of Figure

7-1.

The AFC values given in column 5 are obtained by dividing the TFC values

in

column 2 by the quantity of output in column 1. AVC (column 6) equals TVC (column 3)

divided by output (column 1). ATC (column 7) equals TC (column 4) divided by output

(column 1). ATC also equals AFC plus AVe. MC (column 8) is given by the change in

TVC (column 3) or in TC (column 4) per unit change in output (column 1). Thus, MC

does not depend on TFe. These per-unit cost schedules are plotted in the bottom panel of

Figure 7-1. Note that MC is plotted halfway between the

Table 7-1 and the bottom panel of Figure 7-1 we see that

various levels of output. From

the AVC, ATC, and MC curves

first fall and then rise (i.e., they are U'-shaped). Since the vertical distance between the

ATC and the AVC curves equals AFC, a separate AFC curve is not drawn. Note that AFC

declines continuously as output expands as the given total fixed

costs are spread over

more and more units of output. Graphically, AVC is the slope of a ray from the origin to

the TVC curve, ATC is equal to the slope of a ray from the origin to the TC curve, while

the

MC is the slope of the TC or TVC curves. Note that the MC curve reaches its mini-

mum before (i.e., at a lower level of output) and intercepts from below the AVC and ATC

curves at their lowest points.

We can explain

the V shape of the AVC curve as follows. With labor as the only vari-

able input, TVC for

any output level (Q) equals the wage rate (w, which is assumed to be

fixed) times the quantity of labor (L) used. Thus,

AVC = TVC = wL = ~

Q

Q

QIL

= ~

AP L

[7-6]

Since the average physical product of labor (AP L or QIL) usually rises first, reaches a maxi-

mum, and then falls (see Section 6-2), it follows that the AVC curve first falls, reaches a min-

imum, and then rises. Since the AVC curve is U-shaped, the ATC curve is also U'-shaped. The

ATC curve

continues to fall after the AVC curve begins to rise as long

exceeds the rise in AVe.

as the decline in AFC

The V shape of the MC curve can similarly be explained as follows:

MC

= f

..

TVC

== f

..(wL)

f

..Q

f

..

Q

= w(fo.L) =

f

..

Q

w

f..Qlfo.L

w

MP L

[7-7]

Since the marginal product of labor (MP L or f

..Qlfo.L)first

rises, reaches a maximum, and

then falls, it follows that the MC curve first falls, reaches a minimum, and then rises. Thus,

the rising portion of the MC curve reflects the operation of the law of diminishing returns.

7-3

CHAPTER 7 Cost Theory and Estimation

269

LONG-RUN COST CURVES

In this section

we derive the firm's long-run total, average, and marginal cost curves. We

then show the relationship between the firm's long-run average

cost curve and the firm's

short-run average cost curves.

Long-Run Total Cost Curves

In Section 6-1 we defined the long run as the time period during which all inputs are vari-

able. Thus, all costs are variable in the long run (i.e., the firm faces no fixed costs). The

length of time of the long run depends on the industry. In some

service industries, such as

dry-cleaning, the period of the long run may be only a few months or weeks. For others that

are capital intensive, such as the construction of a new electricity-generating plant, it may

be many years. It all depends on the length of time required for the firm to be able to vary

all inputs.

The firm's long-run total cost (LTC) curve is derived from the firm's expansion path

and shows the minimum long-run total costs of producing various levels of output. The

firm's long-run average and marginal cost curves

are then derived from the long-run total

cost curve. These derivations are shown in Figure 7-2.

The top panel of Figure 7-2 shows the expansion path of the firm. As explained

in

Section 6-5 and Figure 6-11, the expansion path shows the optimal input combinations

to

produce various levels of output. For example, point A shows that in order to produce 1 unit

of output

(lQ), the firm uses 4 units of labor (4L) and 4 units of capital (4K). If the wage of

labor (w)

is $10 per unit and the rental price of capital

(r) is also $10 per unit, the minimum

total

cost of producing 1Q is

(4L)($1O) + (4K)($1O) = $80

This is shown as point A' in the middle panel, where the vertical axis measures total costs

and the horizontal axis measures output. From point C on the expansion path in the top

panel, we get point C ($100) on the LTC curve in the middle panel for 2Q. Other points on

the LTC curve are similarly obtained.' Note that the LTC curve starts at the origin because

there are no fixed costs in the long run.

From the LTC curve we can derive the firm's

LAC is equal to LTC divided by Q. That is,

long-run average cost (LAC) curve.

LAC = LTC

Q

[7-8]

For example. the LAC to produce IQ is obtained by dividing the LTC of $80 (point A' on

the LTC curve in the middle panel of Figure 7-2) by 1. This is the slope of a ray from

the origin to point A'

on the LTC curve and is plotted as point A" in the bottom panel of

3 Point E' on the LTC curve in the

middle panel of Figure 7-2 is based on the assumption that 3Q is produced

with 5.4L and 5.4K (not shown on the expansion

path in the top

panel in order not to clutter the figure), so that

LTC = $108. The shape of the LTC curve will be explained in terms of the LAC curve that is derived from it.

  • 270 PARTTHREE

Production and Cost Analysis

o

LTC ($)

300

456

9

12

15

18

24

LTC

R'

30

Labor

180

120

108 Wo

80

C'

E'

 

o ------.----,~-- _.----_.----_r----,_----------~

Output (Q)

 

o

1

2

3

4

5

6

LAC,

[MC ($)

120

100

80

60

LAC

40

20

o

 

o

1

2

3

4

5

6

Output

FIGURE 7-2

Derivation of the Long-Run Total, Average, and Marginal Cost Curves

From point A on

the expansion path in the top panel, and W= $10 and r= $10, we get point A' on the long-run total cost

(LTC) curve in the middle panel. Other points

on the LTC curve are similarly obtained. The long-run

average

cost (LAC) curve in the bottom panel is given by the slope of a ray from the origin to the LTC curve. The LAC

curve falls up to point G" (4Q) because of increasing returns

to scale and rises thereafter because of

decreasing returns to scale. The long-run marginal cost (LMe) curve is given by the slope of the LTC curve

and intersects the LAC curve from below at the lowest point on the LAC curve.

CHAPTER 7 Cost Theory and Estimation

271

Figure 7-2. Other points on the LAC curve are similarly obtained. Note that the slope of a

ray

from the origin to the LTC curve declines up to point G' (in the middle panel of Fig-

ure 7-2) and then rises. Thus, the LAC curve

(4Q) and rises thereafter.

It is important to keep in mind, however,

in the bottom panel declines up to point G"

that while the U shape of the short-run aver-

age cost (SAC) curve is based on the

operation of the law of diminishing returns (resulting

from the existence of fixed inputs in the short run), the U shape of the LAC curve depends

on increasing, constant, and decreasing returns to scale, respectively, as will be explained

in Section 7-4.

 
 

From the LTC curve we can also derive the long-run marginal cost (LMC) curve.

This

measures the change

in LTC per unit change in output and is given

by the slope of the

LTC curve. That is,

 

LMC = D.LTC

[7-9]

~Q

For example, increasing output from OQ to lQ increases LTC from $0 to $80. Therefore,

LMC is $80 and is plotted at 0.5 (i.e., halfway between OQ and 1Q) in the bottom panel of

Figure 7-2. Increasing output from IQ to 2Q leads to an

increase in LTC from $80 to $100,

or $20 (plotted at 1.5 in the bottom panel), etc. Note that the relationship between LMC and

LAC is the same as that between the short-run MC and ATC or AVe. That

is, the LMC curve

reaches its lowest point at a smaller level of output than the LAC curve

and intersects the

LAC curve from below at the lowest point on the LAC curve.

Long-Run Average and Marginal Cost Curves

The long-run average cost (LAC) curve shows the lowest average cost of producing each

level of output when the firm can build the most appropriate plant to produce each level of

output. This is shown in Figure 7-3. The top panel of Figure 7-3 is based on the assumption

that the firm can build only four scales of plant (given by SAC" SAC2, SAC 3 , and SAC 4 ),

while

many

the bottom panel of Figure 7-3 is based on the assumption that the firm can build

more or an infinite number of scales of plant.

The top panel of Figure 7-3 shows

that the minimum average cost of producing 1 unit

of output (lQ) is $80 and results when the firm operates the scale of plant given by SAC,

(the smallest scale of plant possible) at point A". The firm can produce 1.5Q at an average

cost

of $70 by using either the scale of plant given by SAC,

or the larger scale of plant given

by SAC 2 at point B* (see the top panel of Figure 7-3). To produce 2Q,

the firm will use scale

of plant SAC2 at point C" ($50) rather than the smaller scale of plant SAC, at point C* (the

lowest point on SAC" which refers to the average cost of $67). Thus, the firm has more

flexibility in the long run than in the short run. To produce 3Q, the firm is indifferent be-

tween using plant SAC 2 or larger plant SAC 3 at point E* ($60). The minimum average cost

of producing 4Q ($30) is achieved when the firm operates plant SAC3 at point G" (the low-

est point on SAC 3 ). To produce 5Q, the firm operates either plant SAC 3 or larger plant SAC 4

at point 1* ($60). Finally, the minimum cost of producing 6Q is achieved when the firm

operates plant SAC 4 (the largest plant) at point R" ($50).

  • 272 PARTTHREE Production and Cost Analysis

$ 100 80 60 40 G" 20 0 Output 0 1 2 3 4 5 6
$
100
80
60
40
G"
20
0
Output
0
1
2
3
4
5
6
$
100
80
LAC
60
40
F"
G"
H"
20
o
Output
o
1
2
3
4
5
6
FIGURE 7-3
Relationship Between the Long-Run and Short-Run Average Cost Curves
In the top

panel, the LACcurve is given by A"B*C"E*G"j*R " on the assumption that the firm can build only four

scales of plant (SAC 1 , SAC 2 , SAC), and SAC 4 ). In the bottom panel, the LACcurve is the smooth curve

A"B"C"D"E"F"G"H"J"N"R"

plants in the long run.

on the assumption that the firm can build

a very large or infinite number of

Thus, if the firm could build only the four

scales of plant shown in the top panel of Fig-

ure 7-3, the long-run average cost curve of the firm would beA"B*C'E*G"J*R". If the firm

could build many more scales of plant, the kinks at points B*, E*, and J* would become

less pronounced, as shown in the bottom panel of Figure 7-3. In the limit, as the number of

scales of plants that the firm can build in the long run increases, the LAC curve approaches

the smooth curve indicated by the LAC curves in the bottom panels of Figures 7-2 and 7-3.

Thus, the LAC curve is the tangent or "envelope" to the SAC curves and shows the mini-

mum

average cost of producing various levels of output in the long run, when the firm can

build any scale of plant. Note that only at point G" (the lowest point on the LAC curve) does

the firm utilize the optimal scale of plant at its lowest point. To the left of point G", the firm

CASE STUDY 7-1

CHAPTER 7 CostTheory and Estimation

273

The Long-Run Average Cost Curve ! in Electricity Generation

Figure 7-4 shows

the estimated LAC curve for a sam-

ple of

114 firms generating electricity in the United

States in 1970. The figure show that LAC

is lowest at

the output level of about 32 billion kilowatt-hours. The LAC curve, however, is nearly L-shaped (the rea- son for and significance of thi are explained in Sec- tion 7-4). In order to avoid the increasing costs that they would incur in producing more power them- selves to satisfy increasing consumer demand, electric

power companies have been buying more and more power from independent power producers. But all of this is changing very rapidly as the indu try braces for deregulation and the end of their monopoly power (see Chapter 12). Furthermore, recent technological advances have greatly reduced the average co t of pro- ducing electricity with micro-turbine generators, and tills may soon provide even small businesses with the choice of generating their own electricity efficiently.

LAC ($)

 
 

5.99

-

e

:= 5.83 -

0

 

.s::

i: 5.67 -

 

'"~

2

5.51

-

:><

0

5.36

-

0

0

•.

5.20 -

 

..

••

0-

5.04

-

 

~

   

.!!!

4.88

-

0

 

c

4.73

-

 

?

 

!

o

I

I

I

I

I

I

I

0

5

10

20

30

40

50

60

Billions of kilowatt-hours

LAC

  • I a

70

FIGURE 7-4 The Long-Run Average Cost Curve in Electricity Generation The figure shows the estimated LAC curve in the generation of electricity in the United States for a sample of 114 firms in 1970. The lowest LAC occurs at the output level of 32 billion kilowatt-hours, but the LAC curve is nearly t-shaped,

Source: L. Christensen and H. Green, "Economies of Scale in U.S. Electric Power Generation," Journal of Politic