L12 - Economics 101:Principles of Microeconomics Professor...

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1 Economics 101:Principles of  Microeconomics Professor Jo Hertel Lecture 12: Producer choice continued Costs in the long run The producer’s decisions; how much to produce in the short run when to stop producing in the short run entry and exit in the long run Long-run competitive equilibrium
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2 What about costs in the long run? As it turns out, the most interesting thing about costs in the long run is how ATC changes when we change the fixed input. In particular, we’ll look at how the minimum cost (and the minimum-cost output) changes when we change the fixed input. Then we’ll know how to produce any quantity with minimum average cost! (by changing FC appropriately). This relationship is known as the long-run average total cost curve (LRATC) .
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3 Effects of changing the fixed input on  ATC Increasing the fixed input increases FC (and hence AFC) a larger ‘spreading effect’ – larger MCO increases the marginal product of all inputs - decreases VC (and hence AVC) q AFC ATC MCO 1 AVC AFC 2 AVC 2 ATC 2 MCO 2 Whether the new minimum cost is higher or lower than before will depend on whether the change in AFC or AVC dominates
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4 The long-run average total cost curve LRATC shows the lowest average total cost for any given quantity of production. Each point on the LRATC is associated with a particular fixed cost. LRATC has the shape on the left – U-shaped ATC 1 ATC 2 ATC 3 LRATC q minimum-cost output at FC 1 minimum-cost output at FC 3 lowest possible minimum-cost output occurs at FC 2
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5 Economies and diseconomies of  Scale There are economies of scale when long-run average total cost declines as output increases. There are diseconomies of scale when long-run average total cost increases as output increases. There are constant returns to scale when long-run average total cost is constant as output increases. ATC q LRATC economies of scale diseconomies of scale constant returns to scale
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6 Reminder: necessary conditions for  perfect competition There are many producers and consumers, none of whom have a large market share –no economies of scale! .
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