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Cost Analysis - Cost Analysis(Continued Estimating L-R Cost...

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Cost Analysis (Continued)
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Estimating L-R Cost Curves 1. Use same approach as we saw for S-R Costs (i.e., define mathematical form, collect data and run a regression analysis). For L-R analysis, usually time-series data is not available – work with cross-sectional data: find firms that operate at different scales and relate their output to their costs. Difficulties: - Firms may use different accounting methods, - Wages and input prices may be different if firms are located in different regions – this fact introduces bias in the estimations - As we saw, the L-R costs function is based on the assumption that firms minimize costs, but actual data may not come from firms that are operating like that, so costs may be overestimated.
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Most estimations of L-R costs have found shapes that suggest strong economies of scale at low output levels that tend to diminish as output increases (the L-R average cost becomes horizontal). Instead of being U-shaped as we theorized, the L-R average cost seems to be L-shaped for most firms
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The minimum efficient scale of a plant is defined as the smallest output at which the L-R average cost is at its minimum (Qm). Firms are interested in estimating this point because plants below this size are in competitive disadvantage – their costs are higher than their larger rivals.
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Example: L-R AC for U.S. Electric Power Christenson and Greene (1976) used a translog cost
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