2.5. Production and Costs in the Long Run

Question 1

Time period: long run

Answer 1

All FOPs are variable (quantity of all FOPs can change)

Question 2

Time period: very long run

Answer 2

Change in the state of technology (technology advances)

Question 3

Deriving the Long Run Average Cost (LRAC) curve (Long Run Production Function)

Answer 3

• many SRAC curves on a big LRAC

Question 4

SRAC and LRAC compared

Answer 4

• SRAC is U-shaped due to increasing / diminishing returns
  where as:
• LRAC is U-shaped due to economies / diseconomies of scale

Question 5

Returns to scale

Answer 5

a ratio of the change in inputs (FOPS) to the change in output (G/S)

Question 6

Increasing returns to scale

Answer 6

occur when: the % change in output > % change in inputs

Question 7

Decreasing returns to scale

Answer 7

occur when: the % change in output < % change in inputs

Question 8

Returns to scale on LRAC

Answer 8

• increasing returns to scale when slope of LRAC falls
• constant returns to scale when LRAC at lowest point or flat
• decreasing returns to scale when slope of LRAC rises

Question 9

Increasing returns to scale leads to

Answer 9

Economies of scale

Question 10

Decreasing returns to scale leads to

Answer 10

Diseconomies of scale

Question 11

a

Answer 11

a

Question 12

Minimum Efficient Scale (MES) of Production

Answer 12

the lowest level of output where long run average cost is minimised
(lowest point of LRAC)

Question 13

Economies of scale

Answer 13

falling long run average costs as output increases.

Question 14

Internal Economies of scale

Answer 14

falling long run average costs as a firm increases its output (scale of production).

• Internal EoS accrue to a firm due to its decision to operate on a larger scale
• occurs when LRAC is falling

Question 15

Types of Internal Economies of scale

Answer 15

Financial
Marketing
Technical
Technological
Risk-bearing
Purchasing
Managerial

Question 16

Internal Economies of scale

Answer 16

rising long run average costs as a firm increases its output (scale of production).

• Internal DoS accrue to a firm due to its decision to operate on a larger scale.
• occurs when LRAC is rising

Question 17

Types of Internal Economies of scale

Answer 17

Demotivation
Lack of coordination
Lack of control
Lack of communication
Inflexibility

Question 18

Avoiding internal diseconomies of scale

Answer 18

1) Human resource management (HRM) focuses on improvements in recruitment, communication, training, promotion, retention and support of faculty and staff. This becomes critical to a business when the skilled workers it needs are in short supply.
2) Performance related pay schemes (PRP) can provide financial incentives for the workforce leading to an improvement in industrial relations and higher productivity.
3) Outsourcing is a tried and tested way of reducing costs whilst retaining control over production although there may be a price to pay in terms of the impact on the job security of workers whose functions might be outsourced to other domestic or overseas companies.

Question 19

Returns to scale and internal EoS / DoS

Answer 19

• Returns to scale (increasing / decreasing) measure changes in output due to changes in factor inputs

whereas:
- Internal EoS / DoS are falling or rising average costs as output (scale of production) increases

Question 20

External economies of scale

Answer 20

falling long run average costs to all firms in an industry.

- LRAC shifting downwards

Question 21

External diseconomies of scale

Answer 21

rising long run average costs to all firms in an industry.

- LRAC shifting upwards

Question 22

Causes of external economies of scale

Answer 22

Investment in transport infrastructure
Investment in R&D facilities
Investment in ICT infrastructure
Relocation of suppliers
Agglomeration (clustering) of similar firms
Raw material costs 
Labour Costs
Production taxes
State of Technology

Question 23

Internal EoS / DoS v.s. External EoS / DoS

Answer 23

• Internal EoS / DoS are the falling or rising average costs one particular firm experiences as it increase output (scale of production) - movement along LRAC

whereas:
- External EoS / DoS are the falling or rising average costs all firms in an industry experience - shift in LRAC