Chp9 ECON111

Principles of Economics
Twelfth Edition
Chapter 9
Long-Run Costs
and Output
Decisions
Copyright © 2017 Pearson Education, Inc. 9-1

1-1
Long-Run Costs and Output Decisions
Output decisions in the long run are less constrained than in the short run:
 Firms can choose their scale of plant and change any or all of its inputs.
 Firms are free to enter and leave the industry.
Managers simultaneously make short-run and long-run decisions, making the

best of the current constraints while planning for the future.

1-2
Short-Run Conditions and Long-Run Directions
We begin our discussion of the long run by looking at firms in three short-run
circumstances:
 Firms that earn economic (positive) profits
 Firms that earn normal rate of return and makes zero economic profit:
breaking even
 Firms that suffer economic losses (negative profit)

1-3
Maximizing Profits
Graphic Presentation
A profit-maximizing perfectly competitive firm will produce up to the point

where P* = MC.
 Profit is the difference between total revenue and total cost.
 Because average total cost is derived by dividing total cost by q, we can get
back to total cost by multiplying average total cost by q.

1-4
Breaking even (zero economic profit)
industry a representative firm

P ($) P ($) MC
S
E
P* MR=d
P*
Q Q* Q
Profit-maximizing firm will produce ∗

units of output, i.e. at ∗
,

1-5
Breaking even (zero economic profit)
At ∗
:
∗ ∗
∗ ∗ ∗
A
Then
Long-run response: No firm wants to exit from the industry & no new firm
wants to enter into the industry.

1-6
Economic Profit

P ($) P ($) MC
S
E
P* MR=d
P*
Q Q* Q

,

1-7
Economic Profit
At ∗
:
∗ ∗
A ∗ ∗
B C
Then
∗
0
Long-run response: New firms enter into the industry.

1-8
Economic Loss
If then
Two possible cases in the short-run:
 Continue to produce
(TR, TVC and TFC)
 Shut down
(No TR, No TVC, pay only TFC)

1-9
Economic Loss
If total revenue exceeds total variable cost, the excess revenue can be used to
offset fixed costs and reduce losses, and it will pay the firm to keep operating.
If total revenue is smaller than total variable cost, the firm that operates will
suffer losses in excess of fixed costs. In this case, the firm can minimize its
losses by shutting down and paying only fixed costs.
Operate:
Shut down:
1-10
Economic Loss

MC
P ($) P ($)
S
E
P* MR=d
P*
Q Q* Q

,

1-11
Economic Loss At ∗
:
∗ ∗
MC
ATC ∗ ∗
P ($)
Then
AVC
C
B
A
P* MR=d
Continue to operate or shut down?
D ∗ ∗
E
0 Q*
∗
Q
Long-run response: Loss-making firm exits from the industry.

1-12
Economic Loss

MC
P ($) P ($)
S
E
P* MR=d
P*
Q Q* Q

,

1-13
Economic Loss At ∗
:
ATC ∗ ∗
MC
∗ ∗
P ($) C
B AVC
Then
D E
MR=d
P* A Continue to operate or shut down?
∗ ∗
0 Q*
∗
Q
Loss if it contiunes to
Long-run response: Loss-making firm exits from the industry. operate?

1-14
Economic Loss
then



shutdown point (shutdown price: 𝒔𝒅 ) The lowest point on the average

variable cost curve. When price falls below the minimum point on AVC, total
revenue is insufficient to cover variable costs, and the firm will shut down and
bear losses equal to fixed costs.
 𝒔𝒅
 𝒔𝒅
 𝒔𝒅

1-15
Short-Run Supply Curve of a Perfectly Competitive Firm
At prices below average variable

cost, it pays a firm to shut down
rather than continue operating.
Thus,
the short-run supply curve of a

competitive firm is the part of
its marginal cost curve that lies
above its average variable cost
curve.

1-16
The industry supply curve in the short run is the horizontal sum of the
marginal cost curves (above AVC) of all the firms in an industry
240 300
300
If there are only two firms in the industry, the industry supply curve is simply
the sum of all the products supplied by these firms at each price.
For example, at $6 each firm supplies 150 units, for a total industry supply of
300.

1-17
Long-Run Directions: A Review
Short-Run Short-Run Decision Long-Run Decision
Condition
Profit TR > TC P = MC: operate Expand: new firms
enter
Loss TR > TVC P = MC: operate Contract: firms exit
(loss < total fixed
cost)
Loss TR < TVC Shut down: Contract: firms exit
loss = total fixed cost
Loss TR=TVC Indifferent (operate or Contract: firms exit

shut down)
Breaking TR=TC P = MC: operate No entry and exit
even

1-18
Ex: You are given the following cost data:
q TFC TVC MC MR
0 12 0 ─
1 12 5 5 7
2 12 9 4 7
3 12 14 5 7
4 12 20 6 7
5 12 28 8 7
6 12 38 10 7
If the price of output is $7, how many units of output will this firm produce?
What is the total revenue? What is the total cost? Will the firm operate or
shut down in the short-run, and in the long run?
To determine profit maximizing output level compare MR(=P=$7) & MC

values
Profit-maximizing output level: ∗

1-19
q TFC TVC MC MR At ∗
0 12 0 ─
1 12 5 5 7
2 12 9 4 7
3 12 14 5 7
4 12 20 6 7
5 12 28 8 7
→ Economic Loss
6 12 38 10 7
→ Opera ng proﬁt: The ﬁrm will con nue to produce in

the short-run.
The firm will exit from the market in the long-run.

1-20
Ex: A firm has MCs given by and average variable costs
If fixed costs are 5000 and the market P is 100, find the firm’s maximum profit.
Will the firm continue to operate in the short-run? In the long-run?

1-21
Continue
Shut down
 Compare TR and TVC:
Continue in
 Compare P and AVC: the short-
run
 Compare loss for the shut down and operation cases:
Exit in the
 Compare P and : long-run

1-22
Long-Run Costs: Economies and Diseconomies of Scale
long-run average cost curve (LRAC) Shows the way per-unit costs change
with output in the long run.
 all inputs: variable inputs (not limited to current scale of production) all
costs are variable.
Relationship between the amount of inputs and the corresponding output level
(how LRAC is changing) is studied through returns to scale:
 increasing returns to scale or economies of scale

 constant returns to scale
 decreasing returns to scale or diseconomies of scale

1-23
Increasing Returns to Scale
As the amount of inputs increases, the amount of output increases more.
LRAC (cost per unit output) decreases.
An increase in a firm’s scale of production leads to lower costs per unit

produced.
Some economies of scale result not from technology but from firm-level
efficiencies (greater specialization of inputs).

1-24
Constant Returns to Scale
Technically, the term constant returns means that the quantitative relationship
between input and output stays constant, or the same, when output is
increased.
LRAC (cost per unit output) stays the same.
An increase in a firm’s scale of production has no effect on costs per unit

produced.
Constant returns to scale means that the firm’s long-run average cost curve
remains flat (horizontal LRAC).

1-25
Diseconomies of Scale
As the amount of inputs increases, the amount of output increases less
LRAC (cost per unit output) increases.
An increase in a firm’s scale of production leads to higher costs per unit

produced.
Decreasing returns to scale, or diseconomies of scale is mainly resulting from

the management complexity.

1-26
Graph of Long-Run Average Cost Curve
optimal scale of plant The scale of plant that minimizes long-run average cost.
In the short-run AC (SRAC) curve is always U-shaped, but for the long-run,
returns to scale will determine the shape of LRAC curve:
 Only economies of scale: Downward-sloping LRAC

 Only diseconomies of scale: Upward-sloping LRAC
 Only constant returns to scale: Horizontal LRAC
 Constant returns to scale until some output level, diseconomies of scale for
the rest: Horizontal then upward-sloping LRAC, etc.

1-27
A Firm Exhibiting Economies and Diseconomies of Scale
Economies of scale push this firm’s average costs down to q*.
Beyond q*, the firm experiences diseconomies of scale; q* is the level of

production at lowest long-run average costs, using optimal scale.
1-28
Long-Run Adjustments to Short-Run Conditions
Equilibrium: Balance of forces.

No tendency to change in the market.
Short-run profits:
In the long-run: new firms want to enter into the market
Disequilibrium
Short-run loss:
In the long-run: Loss-making firm exits from the market
Disequilibrium
Equilibrium: No loss or profit in the short-run.

1-29
Short-Run Profits: Expansion to long-run equilibrium
Short-run profits In the long-run: new firms want to enter into the
market
Industry S
Equilibrium P
Profits
P decreases until zero profit (breaking even)
∗

1-30
Short-Run Losses: Contraction to long-run equilibrium
Short-run loss In the long-run: Loss-making firm exits from the

market
Industry S
Equilibrium P
Loss
P increases until no loss (no profit: breaking even)
∗

1-31
Long-Run Competitive Equilibrium
In equilibrium, each firm has:
Firms make no excess profits so that:
and there are enough firms so that supply equals demand.

1-32
Ex: a. Complete the following table for a single firm in the short run:
q TFC TVC TC AVC ATC MC

0 300 0 300 ─ ─ ─
1 300 100 400 100 400 100
2 300 150 450 75 225 50
3 300 210 510 70 170 60
4 300 290 590 72.5 147.5 80
5 300 400 700 80 140 110
6 300 540 840 90 140 140
7 300 720 1020 102.9 145.7 180
8 300 950 1250 118.8 156.25 230
9 300 1240 1540 137.8 171.1 290
10 300 1600 1900 160 190 360

1-33
b. Using the information in the table, fill in the following supply schedule for this
individual firm under perfect competition, indicate profit (loss) at each output
level.
q TC MC Compare P with MC values.
0 300 ─
1 400 100 P 𝐒 Profit ($)
2 450 50 50 0
3 510 60 70 0 or 3
4 590 80 100 4
5 700 110 130 5
6 840 140
170 6
7 1020 180
8 1250 230 220 7
9 1540 290 280 8
10 1900 360 350 9
Shut-down price :

1-34
c. Now suppose there are 100 firms in this industry, all with identical cost
schedules. Fill in the market quantity supplied at each price in this market:
Quantity Market Market

Price supplied (by Price quantity quantity
a firm) supplied demanded
50 0 50 0x100=0 1000
70 0 or 3 70 3x100=300 900
100 4 100 400 800
130 5 130 500 700
170 6 170 600 600
220 7 220 700 500
280 8 280 800 400
350 9 350 900 300

1-35
d. Fill in the blanks: From the market supply and demand schedules in c,
the equilibrium market price for this good is $170 and the equilibrium
quantity is 600 units. Each firm will produce a quantity of 6 units and earn
a (profit/loss) equal to $180.
P 𝐬 Profit ($) Price Market 𝒔 Market 𝒅
50 0 50 0 1000
70 0 or 3 70 300 900
100 4 100 400 800
130 5 130 500 700
170 6 170 600 600
220 7 220 700 500
280 8 280 800 400
350 9 350 900 300

1-36
e. In part d, the answers characterize the short-run equilibrium in this market. Do
they characterize the long-run equilibrium as well? If yes, explain why. If no,
explain why not (i.e., what would happen in the long run to change the
equilibrium, and why?).
The equilibrium market price for this good is $170 and the equilibrium quantity
is 600 units. Each firm will produce a quantity of 6 units and earn a profit
equal to $180.

1-37
Ex: For cases A through F below, would you (a) operate or shut down in the short
run, and (b) stay or exit the industry in the long run?
A B C D E F
TR 1500 2000 2000 5000 5000 5000
TC 1500 1500 2500 6000 7000 4000
TFC 500 500 200 1500 1500 1500
Profit 0 500 -500 -1000 -2000 1000

Shut Shut
Short-run Operate Operate Operate Operate
down down
Long-run Stay Stay Exit Exit Exit Stay

1-38
Study Questions
Q1. Your coffee mug company is currently producing at an output level of 200 units
per month. Fixed costs are $500 per month. At the current output level, you know
that MC is $10 and equal to ATC. At an output level of 150, you have determined
that MC would be $6 and equal to AVC. The market P for your coffee mugs is $8. If
your goal is profit maximization, should you continue at q=200, increase q above
200, or reduce q below 200? Would you do better to shut down? What is shut-
down price?
Q2. Consider the following table of long-run total cost for two different firms:
Output 1 2 3 4 5 6 7
Firm A 60 70 80 90 100 110 120
Firm B 11 24 39 56 75 96 119
Does each firm experience economies of scale or diseconomies of scale?

1-39
Q3. A perfectly competitive industry consists of 1000 firms. Because of their
location, 400 of the firms (type A firms) have higher costs. The cost schedules of
the two types of firm are given:
Output (q) 1 2 3 4 5 6 7 8 9
MC: Type A firm 4 3 4 5 7 10 15 23 40
MC: Type B firm 3 2 3 4 5 7 10 15 23
Assume that minimum AVC is equal to TL4.50 for type A firm and TL3.50 for type B
firm. What will short-run industry supply be at each of the following prices?
Price (TL) 15 7 4 3
Industry supply

1-40
REVIEW TERMS AND CONCEPTS
breaking even long-run competitive equilibrium
constant returns to scale net operating revenue
decreasing returns to scale or optimal scale of plant

diseconomies of scale short-run industry supply curve
increasing returns to scale or economies shutdown point
of scale
economic profit
economic loss
long-run average cost curve (LRAC)

1-41

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Principles of Economics

Copyright © 2017 Pearson Education, Inc. 9-1

Managers simultaneously make short-run and long-run decisions, making the

Copyright © 2017 Pearson Education, Inc. 9-2

 Firms that earn economic (positive) profits

 Firms that suffer economic losses (negative profit)

Copyright © 2017 Pearson Education, Inc. 9-3

A profit-maximizing perfectly competitive firm will produce up to the point

 Profit is the difference between total revenue and total cost.

Copyright © 2017 Pearson Education, Inc. 9-4

industry a representative firm

Profit-maximizing firm will produce ∗

Copyright © 2017 Pearson Education, Inc. 9-5

Copyright © 2017 Pearson Education, Inc. 9-6

industry a representative firm

Profit-maximizing firm will produce ∗

Copyright © 2017 Pearson Education, Inc. 9-7

Long-run response: New firms enter into the industry.

Copyright © 2017 Pearson Education, Inc. 9-8

Copyright © 2017 Pearson Education, Inc. 9-9

industry a representative firm

Profit-maximizing firm will produce ∗

Copyright © 2017 Pearson Education, Inc. 9-11

Long-run response: Loss-making firm exits from the industry.

Copyright © 2017 Pearson Education, Inc. 9-12

industry a representative firm

Profit-maximizing firm will produce ∗

Copyright © 2017 Pearson Education, Inc. 9-13

Copyright © 2017 Pearson Education, Inc. 9-14

shutdown point (shutdown price: 𝒔𝒅 ) The lowest point on the average

Copyright © 2017 Pearson Education, Inc. 9-15

At prices below average variable

the short-run supply curve of a

Copyright © 2017 Pearson Education, Inc. 9-16

Copyright © 2017 Pearson Education, Inc. 9-17

Loss TR=TVC Indifferent (operate or Contract: firms exit

Copyright © 2017 Pearson Education, Inc. 9-18

To determine profit maximizing output level compare MR(=P=$7) & MC

Copyright © 2017 Pearson Education, Inc. 9-19

→ Opera ng proﬁt: The ﬁrm will con nue to produce in

The firm will exit from the market in the long-run.

Copyright © 2017 Pearson Education, Inc. 9-20

Copyright © 2017 Pearson Education, Inc. 9-21

 Compare TR and TVC:

 Compare loss for the shut down and operation cases:

Copyright © 2017 Pearson Education, Inc. 9-22

 increasing returns to scale or economies of scale

Copyright © 2017 Pearson Education, Inc. 9-23

As the amount of inputs increases, the amount of output increases more.

LRAC (cost per unit output) decreases.

An increase in a firm’s scale of production leads to lower costs per unit

Copyright © 2017 Pearson Education, Inc. 9-24

LRAC (cost per unit output) stays the same.

An increase in a firm’s scale of production has no effect on costs per unit

Copyright © 2017 Pearson Education, Inc. 9-25

As the amount of inputs increases, the amount of output increases less

LRAC (cost per unit output) increases.

An increase in a firm’s scale of production leads to higher costs per unit

Decreasing returns to scale, or diseconomies of scale is mainly resulting from

Copyright © 2017 Pearson Education, Inc. 9-26

 Only economies of scale: Downward-sloping LRAC

Copyright © 2017 Pearson Education, Inc. 9-27

Economies of scale push this firm’s average costs down to q*.

Beyond q, the firm experiences diseconomies of scale; q is the level of