8.

ECONOMIES/DISECONOMIES OF SCALE

*Economies of scale: cost increases less than proportionally

with the level of output; that is, for 𝜆 > 1,
𝐶 (𝜆𝑄 ) < 𝜆𝐶 (𝑄 ).
*Economies and diseconomies can be observed through
the average cost. Equivalently, then, when there are
economies of scale, the average cost decreases. That is,
𝜕𝐴𝐶(𝑄)
<0
𝜕𝑄
*If the firm’s technology exhibits increasing returns of
scale, then, the firm has economies of scale.

*Diseconomies of scale: cost increases more than

proportionally with the level of output; that is, for 𝜆 > 1,
𝐶 (𝜆𝑄 ) > 𝜆𝐶 (𝑄 ).
*Equivalently, the average cost increases with the level of
output; that is,
𝜕𝐴𝐶(𝑄)
<0
𝜕𝑄
* If the firm’s technology exhibits decreasing returns of
scale, then, the firm has diseconomies of scale.
*Constant economies of scale (nor economies, nor
diseconomies): cost increases proportionally with the level
of production; that is, for 𝜆 > 1,
𝐶 (𝜆𝑄 ) = 𝜆𝐶 (𝑄 ).
* Equivalently, the average cost is constant; that is,
𝜕𝐴𝐶(𝑄)
=0
𝜕𝑄

* If the firm’s technology exhibits constant returns of scale,

then, the firm has constant economies of scale.

EXAMPLES:
𝑄2
1. 𝐶 (𝑄 ) = + 36
36
2𝑄 𝑄
𝑀𝐶 (𝑄 ) = = Increasing.
36 18
𝑄 36
𝐴𝑇𝐶 (𝑄 ) = + U – shaped.
36 𝑄
𝜕𝐴𝑇𝐶(𝑄) 1 36
= − = 0, 𝑄̇ = 1
𝜕𝑄 36 𝑄2

This firm has economies of scale until the minimum of the

Average Total Cost, 𝑄 = 1. For that level of output, it has
constant returns of scale, and, for greater levels of output
it has decreasing returns of scale.
2. 𝐶 (𝑄 ) = 4√𝑄
2
𝑀𝐶 (𝑄 ) = Decreasing.
√𝑄
4
𝐴𝑇𝐶 (𝑄 ) = Decreasing. Economies of scale.
√𝑄

3. 𝐶 (𝑄 ) = 4𝑄
𝑀𝐶 (𝑄 ) = 𝐴𝑇𝐶 (𝑄 ) = 4 Constant. Constant
economies of scale.

9. COST CURVES

SHORT RUN
Representation of Total, Variable and Fixed Costs Curves.
*Fixed Cost does not depend on the level of output.

*To represent the Variable Cost, we need to consider how

does labour input behaves in the short run. The first units
of input are increasingly productive until a certain level, 𝐿0 .
From that level, additional units of labour are increasingly
less productive.
*Therefore, if for the first additional units, labour is
increasingly productive, it means that additional units of
output require increasingly less units of labour. So, the
additional cost of producing an additional unit of output
(Marginal Cost) is decreasing, and, therefore, Variable Cost
increases at a slower rate (it is concave).
*From 𝐿0 , labour input becomes less productive, so more
units of labour are needed to produce an additional unit of
output. This means that the Variable Cost increases at a
faster rate (it is convex).

*Variable Cost is U – shaped, it is concave until a level of

output and then becomes convex.
*Fixed Cost is horizontal.
*Total Cost is the addition of both Variable and Fixed Costs.
*Representation of Marginal, Average Total and Average
Variable Costs.
Again, we need to consider Marginal and Average
Productivity Curves.

*Both curves are increasing up to a certain level, from

which they decrease.
*Marginal Cost behaves the opposite to Marginal
Productivity of labour while Average Variable Cost is
opposite to Average Productivity of Labour.
*They both are U – shaped and cross at the minimum of the
Average Variable Cost.

*Average Total Cost is U – shaped, as it is the addition of

Average Variable Cost and Average Fixed Cost. Average
Total Cost and Marginal Cost cross at the minimum of the
Average Total Cost.
*Average Fixed Cost is the Fixed Cost divided by the level of
output; therefore, it is always decreasing.
𝐹𝐶
𝐴𝐹𝐶 =
𝑄
LONG RUN
*In the long run all costs are variable, there are no fixed
costs, and the total cost coincides with the variable cost.
*In the long run the firm can choose among all levels of
capital.

*Let us assume that the firm could only choose among

three levels of capital: 𝐾1 , 𝐾2 , 𝐾3 . Which level of capital will
the firm choose to produce each level of output?
*We are going to analyse the long run through the Average
Total Cost, however the analysis is similar if we used the
Total Cost.
*If there are infinite levels of capital:

*To represent Long – run Marginal Cost Curve, the analysis

is similar. What level of capital would the firm choose for
every level of output? The curve is obtained by joining all
the points. Then, the long - run Marginal Cost curve is the
envelope of the short – run Marginal Cost curves.
*When the firm has Economies of Scale and Diseconomies
of Scale, long – run Average and Marginal Costs are U –
shaped.
*Long – run Total Cost is the envelope of short – run Total
Cost curves.
C(Q) C(Q)

*These previous long – run graphs represent the case of a

firm with Economies of Scale up to a level of output, and
from it, Diseconomies of Scale.

*How are these curves represented when the firm has

Economies of Scale for every level of output?
Marginal and Average Cost are decreasing, and AC >
MC.
Total Cost increasing and concave.

*How are these curves represented when the firm has

Diseconomies of Scale for every level of output?
Marginal and Average Cost are increasing, and AC <
MC.
Total Cost increasing and convex.
*How are these curves represented when the firm has
Constant Economies of Scale for every level of output?
Marginal and Average Cost are constant, and AC = MC.
Total Cost increasing and linear.

10. PRODUCTION EXPANSION PATH

It is the set of optimal combination of inputs that the firm
should choose for every level of production, given the
prices of inputs.

*In the long run, both inputs are variable, so the firm can
choose any combination of the isoquant.
*In the short run, capital input is fixed, so the firm uses the
level of labour that requires its technology.