L13 - The Long Run

Question 1

What options of Factor Inputs will a profit maximising firm choose?

Answer 1

The least costly option

Question 2

What happens to the factor inputs in the long run?

Answer 2

All factors are variable. With no fixed costs to production.

Including Rent. Which is fixed in SR is variable in the LR

Question 3

What are the assumptions behind Long Run Costs?

Answer 3

Factor prices are given
• Increase in the factor: prices shifts the short & long-run cost total curves up

Technology and factor quality are given:
• Increase in the factor quality shifts the short & long-run cost total curves
down
• Technology and factor quality can only change in the very long run

Firms are efficient:
• They choose the least costly mix of factor to produce a given output

Question 4

What does a typical Long Run Average Cost Curve look like?

Answer 4

A curve displaying:

• EofS as the costs decrease -Constant Costs when the graph remains constant
• Dis EofS when the graph curves up

(SHOWN IN DIAGRAM)

Question 5

What are Increasing returns to scale?

Answer 5

Doubling inputs raises output by more than double

Question 6

What is a Constant return to scale?

Answer 6

Doubling Inputs, doubles outputs

Question 7

What are decreasing returns to scale?

Answer 7

Doubling inputs raises output by less than double

Question 8

What is Economies of Scale?

Answer 8

Needing to use less inputs per unit of output

Thus, causing cost per unit to fall due to increasing return to scale

Question 9

What are the differing types of Economies of Scale?

Answer 9

• Plant economies: workers in a large firm able to specialise
• Organisational economies: don’t need to duplicate administration
• Financial economies: larger firm can borrow at cheaper rate; can buy in bulk

Question 10

What are Diseconomies of Scale?

Answer 10

Needing to use larger amounts of inputs per unit
Thus, cost per unit rises when there are decreasing returns to scale

• Managerial tasks are more complicated, communication more difficult

Question 11

How do you derive the LRAC from SRAC?

Answer 11

The lowest point of an aggregation of SRAC and overall it shows the LRAC.

(CHECK DIAGRAM)

Question 12

What are Isoquants?

Answer 12

Join all combinations of Labour and Capital that produce the same output.

(SEE DIAGRAM)

Question 13

Why are Isoquants downward sloping?

Answer 13

Because labour and capital are substitutes

SEE DIAGRAM

Question 14

Why are Isoquants bowed toward the origin?

Answer 14

Because an average combination of labour and capital is more productive than extremes.

(SEE DIAGRAM)

Question 15

What is a Isocost line?

Answer 15

Connect all combinations of Labour and Capital that cost the same.

(SEE DIAGRAM)

Question 16

What is the Equation of Isocost line?

Answer 16

TC = rK +wL
rK= TC- wL
K= TC/r - (w/r)L

Where:
Price of capital is r
Price of Labour is w
TC is total cost
L is labour 

(SEE DIAGRAM)

Question 17

What is the slope of the Isocost line?

Answer 17

ΔK/ΔL = –(w/r)

SEE DIAGRAM

Question 18

How do you figure out the least-cost input combination?

Answer 18

Since Isoquants show output levels. Isocosts lines show total costs.

Putting them together finds the level of L and K that minimises total costs.

(SEE DIAGRAM)

Question 19

What is the Shut Down Rule in the Long Run?

Answer 19

If the market price is below the LRAC.

Question 20

What is the Profit Maximisation in the Long Run?

Answer 20

Profits are maximised at the point where MR=LMRC

The firm will not shut down since P> LRAC