Costs of Production

Long-run
Unit 6 - Lesson 6

Learning outcomes:
Discuss and graph Economies of Scale,
Constant Returns to Scale, Diseconomies of
Scale.
Why firms experience each.
Graph and explain the relationship between
SRAC and the LRAC.

Economies of Scale
Helps us understand how a lot of the goods
and services we consume are so
inexpensive.
Why are flat screen televisions relatively
inexpensive?
What about your phone?

Economies of Scale
Increasing Returns to Scale:
An increase in inputs (factors of
production) leads to a larger
proportional increase in output.
Firm doubles the number of
workers & machines. Firms output
(production) triples.
Firm is experiencing increasing
returns to scale/economies of scale.

https://textimgs.s3.amazonaws.
com/econ/section_11/ef85167aa3fb8d8f0c18a730110f91ff.jpg

Reasons for Economies of Scale

1. Lower price for raw materials because of the ability to
buy in bulk.
2. Lower costs due to better technology and machinery.
3. Lower average shipping costs because of bulk.
4. Better interest rates from banks because the firms are
deemed more credit-worthy.
5. More specialized labor and capital increases output.

Constant Return to Scale

Constant Return to Scale:
Increase in inputs (factors of
production) leads to a
proportional or identical increase
in output.
Firm add 20% more capital, the
output of the firm increases 20%.

Diseconomies of Scale
Decreasing Returns to Scale:
Increase in the number of inputs
(factors of production) leads to a
proportional smaller increase in the
quantity of output.
The firm has gotten TOO BIG!!!

Reasons for Diseconomies of Scale

1. Communication inefficiencies
2. Politics of Business - individuals climbing the
ladder often put the interests of themselves
in front of the business.
3. The larger a business becomes, the more
regulations it faces.

Long-run Average Cost Curve

SRAC 1: Represents Average Costs in the
Short-run operating one factory.
SRAC 2: As the business increases from 1
factories to 2 factories, it experiences
Economies of Scale.
SRAC 3: As the business increases from 2
factories to 3 factories, it begins to experience
Diseconomies of Scale.
Most cost effective size is two factories.

http://mbaeconfall2011.wikispaces.com/file/view/long-run-avg-cost.
PNG/282967734/493x220/long-run-avg-cost.PNG