Production Cost in the Long-Run

Production Cost in the Long-Run:

a) Envelope Curve:

2404_Envelope curve.jpg

b) LRMC Curve:

At point c, LRAC = LRMC = SACB = SMCB

c) Returns to Scale and LRAC Curve:

821_LRAC curve.jpg

(1) Constant Returns to Scale

(2) Increasing Returns to Scale (Economies of Scale or Scale Economy)
→Natural Monopoly

(3) Decreasing Returns to Scale (Diseconomies of Scale)

d) Economies of Scope:

TC(Q1, Q2)< TC(Q1, 0) + TC(0, Q2)

ES= {TC(Q1)+ TC(Q2) -TC(Q1,Q2)}/TC(Q1, Q2), ES > 0 (Scope Economies happen) Sources of Scope Economies: Shared common inputs, cost complementation (oil and benzene, oil and natural gas, computer software and computer support etc.)

e) Economies of Experience (Learning by Doing):

Economies of scale (EOS) and Economies of Experience (EOE) are different. EOS refer to the ability to perform activities at a lower unit cost when those activities are performed on a larger scale at a given point in time. EOE refer to reductions in unit costs due to accumulating experience over time. EOS may be substantial even when EOE is minimal. This is probable to be the case in mature, capital-intensive production processes, such as aluminum can manufacturing. Likewise, EOE may be substantial even when EOS are minimal as in such complex labor-intensive activities as the production of handmade watches.

Firms that don’t correctly distinguish between EOS and EOE draw incorrect inferences about the benefits of size in a market. For example, if a firm has low average costs because of EOS, reductions in the current volume of production will increase unit costs.

If the low average costs are the results of cumulative experience the firm may be able to cut back current production volumes without raising its average costs.

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