This is “Review and Practice”, section 8.3 from the book Economics Principles (v. 1.0).
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In this chapter we have concentrated on the production and cost relationships facing firms in the short run and in the long run.
In the short run, a firm has at least one factor of production that it cannot vary. This fixed factor limits the firm’s range of factor choices. As a firm uses more and more of a variable factor (with fixed quantities of other factors of production), it is likely to experience at first increasing, then diminishing, then negative marginal returns. Thus, the short-run total cost curve has a positive value at a zero level of output (the firm’s total fixed cost), then slopes upward at a decreasing rate (the range of increasing marginal returns), and then slopes upward at an increasing rate (the range of diminishing marginal returns).
In addition to short-run total product and total cost curves, we derived a firm’s marginal product, average product, average total cost, average variable cost, average fixed cost, and marginal cost curves.
If the firm is to maximize profit in the long run, it must select the cost-minimizing combination of factors for its chosen level of output. Thus, the firm must try to use factors of production in accordance with the marginal decision rule. That is, it will use factors so that the ratio of marginal product to factor price is equal for all factors of production.
A firm’s long-run average cost (LRAC) curve includes a range of economies of scale, over which the curve slopes downward, and a range of diseconomies of scale, over which the curve slopes upward. There may be an intervening range of output over which the firm experiences constant returns to scale; its LRAC curve will be horizontal over this range. The size of operations necessary to reach the lowest point on the LRAC curve has a great deal to do with determining the relative sizes of firms in an industry.
This chapter has focused on the nature of production processes and the costs associated with them. These ideas will prove useful in understanding the behavior of firms and the decisions they make concerning supply of goods and services.
Which of the following would be considered long-run choices? Which are short-run choices?
How would each of the following affect average total cost, average variable cost, and marginal cost?
Consider the following types of firms. For each one, the long-run average cost curve eventually exhibits diseconomies of scale. For which firms would you expect diseconomies of scale to set in at relatively low levels of output? Why?
The table below shows how the number of university classrooms cleaned in an evening varies with the number of janitors:
|Janitors per evening||0||1||2||3||4||5||6||7|
|Classrooms cleaned per evening||0||3||7||12||16||17||17||16|
Characterize the nature of marginal returns in the region where
The director of a nonprofit foundation that sponsors 8-week summer institutes for graduate students analyzed the costs and expected revenues for the next summer institute and recommended that the session be canceled. In her analysis she included a share of the foundation’s overhead—the salaries of the director and staff and costs of maintaining the office—to the program. She estimated costs and revenues as follows:
|Projected revenues (from tuition and fees)||$300,000|
|Room and board for students||$100,000|
|Costs for faculty and miscellaneous||$175,000|
What was the error in the director’s recommendation?
The table below shows the total cost of cleaning classrooms:
|Classrooms cleaned per evening||0||3||7||12||16||17|
The information in the table explains the production of socks. Assume that the price per unit of the variable factor of production (L) is $20 and the price per unit of the fixed factor of production (K) is $5.
|Units of Fixed Factor (K)||Units of Variable Factor (L)||Total Product (Q)|
The table below shows the long-run average cost of producing knives:
|Knives per hour||1,000||2,000||3,000||4,000||5,000||6,000|
|Cost per knife||$2||$1.50||$1.00||$1.00||$1.20||$1.30|
Suppose that the price of labor is $10 per unit and the price of capital is $20 per unit.