Cost Analysis

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

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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.
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.
Example: L-R AC for U.S. Electric Power Christenson and Greene (1976) used a translog cost function, cross-section data for investor-owned utilities

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## This note was uploaded on 04/07/2008 for the course ECON 2010 taught by Professor Devkota during the Spring '08 term at Rensselaer Polytechnic Institute.

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

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