2.5. Production and Costs in the Long Run Flashcards
Time period: long run
All FOPs are variable (quantity of all FOPs can change)
Time period: very long run
Change in the state of technology (technology advances)
Deriving the Long Run Average Cost (LRAC) curve (Long Run Production Function)
- many SRAC curves on a big LRAC
SRAC and LRAC compared
- SRAC is U-shaped due to increasing / diminishing returns
where as: - LRAC is U-shaped due to economies / diseconomies of scale
Returns to scale
a ratio of the change in inputs (FOPS) to the change in output (G/S)
Increasing returns to scale
occur when: the % change in output > % change in inputs
Decreasing returns to scale
occur when: the % change in output < % change in inputs
Returns to scale on LRAC
- 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
Increasing returns to scale leads to
Economies of scale
Decreasing returns to scale leads to
Diseconomies of scale
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Minimum Efficient Scale (MES) of Production
the lowest level of output where long run average cost is minimised
(lowest point of LRAC)
Economies of scale
falling long run average costs as output increases.
Internal Economies of scale
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
Types of Internal Economies of scale
Financial Marketing Technical Technological Risk-bearing Purchasing Managerial
Internal Economies of scale
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
Types of Internal Economies of scale
Demotivation Lack of coordination Lack of control Lack of communication Inflexibility
Avoiding internal diseconomies of scale
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.
Returns to scale and internal EoS / DoS
- 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
External economies of scale
falling long run average costs to all firms in an industry.
- LRAC shifting downwards
External diseconomies of scale
rising long run average costs to all firms in an industry.
- LRAC shifting upwards
Causes of external economies of scale
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
Internal EoS / DoS v.s. External EoS / DoS
- 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
