COST ANALYSIS

IN THE LONG-
RUN
Managerial Economics
Presented by group 5
 1 Introduction to the Long-run

2 Long-run Cost Curves

Returns to Scale & Economies of Scope

AGENDA 3

4 Overall Cost structure

5 Long-run vs Short-run
I. INTRODUCTION
Definition of long-run and what happened to all the
factors in the long run.
What is the Long-
run?

The long run is a period of time in

which all factors of production and costs
are variable. In the long run, the firm can
freely vary all of its inputs. In other
words, there are no fixed inputs or fixed
costs.
II. Long-run Cost Curves
 Long-run total cost

The concept of long-run total cost is an important consideration

for firms when making decisions about their production levels
and input choices.

Long-run total cost (LRTC) can be calculated by the function:

LRTC = f(Q)
With Q is the quantity of product over a long period of time

Suppose you are managing a candy company
with the function is:
LRTC = 10Q + 0.5Q^2
Q is the quantity of candy produced
If the company produces 1,000 pieces of candy,
the LRTC will be
10,000 + 0.5 x 1000^2 = 510,000 VND
However, if the company produces 2,000 pieces
of candy, the LRTC will be
20,000 + 0.5 x 2000^2 = 820,000 VND
=> With a specific LRTC function, the company
can calculate candy production costs for any
quantity of candy and use the results to make
business decisions.
=
Long-run total cost curve

In graphically deriving the LRTC curve, the minimum points of the SRTC curves
at different levels of output are joined. The locus of all these points gives us the
LRTC curve.
 Long-run average cost
Long-run average total cost (LRAC) is a business metric that
represents the average cost per unit of output over the long run, where
all inputs are considered to be variable and the scale of production is
changeable.

Long-run total cost (LRAC) can be calculated by the function:

LRTC = f(Q)/Q
Q is the quantity of product over a long period of time

Suppose you are managing a candy company
with the function is:
LRAC = 10 + 0.5Q
Q is the quantity of candy produced
If the company produces 1,000 pieces of
candy, the LRTC will be
10 + 0.5 x 1000 = 510 VND
However, if the company produces 2,000
pieces of candy, the LRTC will be
10 + 0.5 x 2000 = 1010 VND
=> With a specific LRTC function, for this
equation, The company can calculate the
cost per unit.
Long-run average cost curve
 Long-run marginal cost

The change in long-run total cost divided by the change in

quantity.

In the long run, all the inputs are variable so the marginal products
and the law of diminishing marginal returns are no more relevant to
the LMC.
The long-run marginal cost
is extremely important to
the long-run profit
maximization of a firm.

A firm can maximizes economic

profit in the long run by
equating marginal revenue
with long-run marginal cost
III. RETURNS TO SCALE
Are larger firms more efficient producers than small firms?
Would a 20% percent increase in size of production reduce
average cost per unit?
 1 2 3

Constant Declining Increasing

Average Cost Average Cost Average Cost
Constant AC
Average production cost per unit
remain unchanged with rising
scale

• Production process replication

• Management functions
Declining AC
Rising the production volume would in turn
decline the average cost:
• Capital-intensive mass production
techs, automation, labor specialization,
advertising and distribution
Increasing AC
Climbing average cost as production
expands:

• Problems of organization,
information and control in very
large firms.
Minimum Efficient
Scale
The lowest output at which
minimum average cost can be
achieved.

MES is also important in

determining how many firms a market
can support.
Economies of scope
Producing variety of
goods, potential cost
advantages
Producing multiple goods is
less than the aggregate cost of
producing each item.
Fomula:
C(Q1) denotes the cost of producing
good 1 alone and similarly for C(Q2)
C(Q1, Q2) denotes the firm’s cost of
jointly producing the goods in the
respective quantities.
Economies of scope
Example: Suppose producing the
goods separately means incurring costs
of $12 million and $8 million,
respectively. The total cost of jointly
producing the goods in the same
quantities is $17 million.

SC = (12 + 8 + 17)/(12 + 8) = 0.15

=> Joint production implies a 15% cost

savings
IV. COST STRUCTURE IN
THE LONG RUN
In the long run, there is no fixed
cost, all costs are variable!
Alternative production
technologies
Lower costs lead to higher
profits.
--> The firm will search for the
production technology that
allows it to produce the desired
level of output at the lowest cost.
 Economies of Scale

After determining the least

costly production technology,
the company can consider the
optimal quantity of output to
produce

--> Economies of scale refer to the

situation where, as the quantity of
output goes up, the cost per unit
goes down.
Shapes & Shifting patterns of long run average
cost curves
Shapes of LRACC
Shows the cost of producing each
quantity in the long run, when the firm
can choose its level of fixed costs and
thus choose which short-run average
costs it desires.

Shifting patterns of LRACC

Can be shifted due to the
development of production
technology in ways that can alter
the size distribution of firms in an
industry.
The size and number of firms in an industry
The shape of the long-run average cost curve has implications for how
many firms will compete in an industry, and whether the firms in an
industry have many different sizes, or tend to be the same size.
Comparison
Short-run vs Long-run cost
Comparison Short Run Long Run

There are no fixed inputs

Containing both fixed and
Factors or fixed costs; all costs are
variable input
variable.

Production Variable proportion type of Fixed production type of

Function production function. production function.

Capital to labor Shifts with the shifts in Doesn’t shift with the
(Ratio) output. shifts in output.
Thank you for listening