Supply 2

1
Supply (2)

• Supply (2) Long-run Costs

2
Reading

• Sloman Economics (5th edition)
• Pages 134-137

3
Guide to making notes / learning objectives

• Explain how the shape of the long-run average
  cost (LRAC) curve relates to the phenomena of
  increasing, decreasing, and constant returns to
  scale, and to economies of scale, diseconomies of
  scale and constant costs.
• List assumptions behind LRAC curve
• Explain relationship between SRAC and LRAC.

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LONG-RUN COSTS

• Long-run average costs
• shape of the LRAC curve

5
Alternative long-run average cost curves
Economies of Scale
Costs
O
Output
6
Alternative long-run average cost curves
Diseconomies of Scale
Costs
O
Output
7
Alternative long-run average cost curves
Constant costs
Costs
O
Output
8
A typical long-run average cost curve
Costs
O
Output
9
A typical long-run average cost curve
Economies of scale
Constant costs
Diseconomies of scale
Costs
O
Output
10
Assumptions behind the curve

• Input prices do not change
• The state of technology and quality of inputs
  does not change
• Firms choose the least-cost combination of inputs
  for each output.

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LONG-RUN COSTS

• Long-run marginal costs and the relationship with
  long-run average costs

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Long-run average and marginal costs
Economies of Scale
Costs
LRAC
O
Output
13
Long-run average and marginal costs
LRAC
Diseconomies of Scale
Costs
O
Output
14
Long-run average and marginal costs
Constant costs
Costs
LRAC
LRMC
O
Output
15
Long-run average and marginal costs
Initial economies of scale, then diseconomies of
scale
LRAC
Costs
O
Output
16
Relationship between long-run and short-run
average costs

• - The envelope curve

17
Deriving long-run average cost curves factories
of fixed size
1 factory
Costs
2 factories
3 factories
O
Output
18
Deriving long-run average cost curves factories
of fixed size
SRAC5
SRAC1
SRAC2
SRAC4
SRAC3
LRAC
Costs
O
Output
19
Long-run cost curves in practice

• Minimum efficient scale
• See case study on pages 136-137