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Economics
6th edition, Global Edition

Chapter 11
Technology, Production, and
Costs

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Chapter Outline
11.6 Costs in the Long Run

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Table 11.4 A summary of calculations from Lecture 8

Marginal Product An increase in total product resulting MP =

from hiring another unit of variable input
Average Product Total product divided by the quantity of AP =
variable input
 Long-run theory of production
The scale of production:

– Constant return to scale

A given percentage increase in inputs will lead to the
same percentage increase in output.

– Increasing return to scale

A given percentage increase in inputs will lead to the
larger percentage increase in output.

– Decreasing return to scale

A given percentage increase in inputs will lead to the
smaller percentage increase in output.

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 Short-run and long-run increases in output

Short run Long run

Input 1 Input 2 Output Input 1 Input 2 Output

3 1 25 1 1 15

3 2 45 2 2 35

3 3 60 3 3 60

3 4 70 4 4 90

3 5 75 5 5 125

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 Costs in the Long Run
Recall that the long run is a sufficiently long period of time
that all inputs are variable and all costs are variable.

• So In the long run, there is no distinction between fixed and

variable costs.

The Production Function

The behavior of long-run cost depends upon the firm’s

production function - the relationship between the maximum
output attainable and the quantities of both capital and labor.

A long-run average cost curve shows the lowest cost at which

a firm is able to produce a given quantity of output in the long run,
when no inputs are fixed.
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Figure 11.6 The relationship between short-run average cost

and long-run average cost

At low quantities, a firm

might experience
economies of scale:
the firm’s long-run
average costs falling as
it increases the quantity
of output it produces.
Here, a small car
factory can produce at a
lower average cost than
a large one, for small
quantities. For more
output, a larger factory
is more efficient.
 Economies of Scale

The concept of increasing return to scale is

closely linked to economies of scale

- If a firm is getting increasing returns

to scale from its factors of production, as
it produces more, it will be using smaller
and smaller amounts of factors per unit
of output. Other things being equal, it
will be producing at a lower unit cost.

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 Economies of Scale

Reasons that bring large firms towards economies of scale

(internal):

1) Specialisation and division of labour – production is

broken down into a number of simpler, more
specialised tasks, allowing workers to acquire a
high degree of efficiency.

2) The ‘container principle’ – the larger the size of

container, the less costly per unit of output. The
larger the container, the bigger volume relative to
surface area.
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 Economies of Scale

3) Greater efficiency of large machines – can gain

more output for a given input by using large machine.

4) Indivisibilities – some inputs are of minimum sizes,

they are indivisible. A small-scale business could not
make full use of a machinery, especially when
different machines are used for different processes.

5) By-products – with production on a large scale might

have sufficient waste products to make some by-
products.
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 Economies of Scale

6) Multistage production – A large factory able to take a

product through several stages in its manufacture.
This saves time and cost in moving semi-finished
products.

7) Organisational & administrative economies – Large firm can

specialize in particular functions. Administration can also
be centralised.

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 Economies of Scale

8) Spreading overhead – the greater the firm’s output, the more

these overhead costs are spread.

9) Financial economies – large firms can obtain finance at lower

lower interest rates and obtain certain inputs cheaper by
buying in bulk.

10) Economies of scope – when increasing the range of products

produced by a firm. Overhead costs, financial and
organizational economies can be shared among products.

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Figure 11.6 The relationship between short-run average cost

and long-run average cost
The lowest level of
output at which all
economies of scale are
exhausted is known as
the minimum efficient
scale.
At some point, growing
larger does not allow
more economies of
scale. The firm
experiences constant
returns to scale: its
long-run average cost
remains unchanged as
it increases output.
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Long-run average cost curves for

automobile factories
Why might a car company experience economies of scale?
• Production might increase at a greater-than-proportional rate as
inputs increase.
• Having more workers can allow specialization.
• Large firms may be able to purchase inputs at lower prices.
But economies of scale will not last forever.
• Eventually managers may have difficulty coordinating huge
operations.
“Demand for… high volumes saps your energy. Over a period of
time, it eroded our focus… [and] thinned out the expertise and
knowledge we painstakingly built up over the years.”
- President of Toyota’s Georgetown plant
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Figure 11.6 The relationship between short-run average cost

and long-run average cost

Eventually, firms
might get so large
that they experience
diseconomies of
scale: a situation in
which a firm’s long-
run average costs
rise as the firm
increases output.
 Diseconomies of Scale

Diseconomies of scale (internal) is closely linked to decreasing

returns to scale.

Reasons that bring towards diseconomies of scale:

1) Management problems of co-ordination as firms become

larger and more complex.

2) The firm has to employ workers or other factors of production

that are less well suited to production.

3) Workers feel alienated if their jobs are boring and repetitive.

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 Diseconomies of Scale

4) More complex interrelationship between different categories of

worker.

5) More complex interdependencies of mass production lead to

great disruption if there are hold-ups in any one part of the
firm.

6) Professionals with years of experience will demand higher

wages.

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 External Economies and Diseconomies
of Scales
External economies of scale

- Firms benefit from the whole industry being

large. Facilities, support services, skills and
experience can be shared by members.

External diseconomies of scale

- As industry grows larger, there will be a growing

shortage of specific raw materials and labor.

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 Summary – Long Run Costs

 Relationship between long-run and short-run

average costs

Long-run average cost curve is derived from

the envelope of the short-run average cost
curves.

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Deriving long-run average cost curves: factories of fixed size

SRAC1 SRAC SRAC5

2
SRAC4
SRAC3

5 factories
Costs

1 factory
2 factories
3 factories 4 factories

O
Output
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Deriving a long-run average cost curve: choice of factory size

LRAC
Costs

O
Output
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