# An inverse relation holds between cost elasticity and

• 17

This preview shows page 10 - 13 out of 17 pages.

-An inverse relation holds between cost elasticity and economies of scale,whereas a direct relation exists between output elasticity and returns to scale. -If cost elasticity is less than 1, average cost is falling and increasing returns to scale are observed. An output elasticity of greater than one implies increasing returns to scale because output is increasing faster than input usage. Short-Run Cost Curves -Short run cost curves relate costs and output for each specific scale of plant -The curve shows the cost-output relation for a specific plant and operating environment. Short-Run Cost Curves for Four Scales of Plant -Short-run cost curves represent the most efficient range of output for a given plant size. The solid portion of SRAC curve indicates the minimum long-run average cost for each level of output -Each of the four plants has a range of output over which it is the most efficient -Plant A, for example, provides the least cost production system for output in the range of 0 to Q1 units; Plant B provides the least cost system for output in the range Q1 to Q2; plant C is the most efficient for output quantities Q2 to Q3; Plant D provides the least cost production process for output above Q3
-The solid portion of each curve indicates the minimum long-run average cost for producing each level of output, assuming only four possible scales of plant Combining Short-Run and Long-Run Cost Curves -The long-run average cost curve is constructed tangent to each short-runaverage cost curve -At each point of tangency – the related scale of plant is optimal; no otherplant can produce that particular level of output at so low a total cost -Cost systems in both figures display first economies of scale, then diseconomies of scale. Over the range of output produced by plants A, B and C in previous figure, average costs are declining; these declining costs mean that total cost are increasing less proportionately with output -Because plant D’s minimum cost is greater than that for plant C, the system exhibits diseconomies of scale at this higher output level -Production systems that reflect first increasing, then constant, then diminishing returns to scale result in U-shaped long run average cost curves such as the one illustrated in the above figure.
-With a U shaped long-run average cost, the most efficient plant for each output level is typically not operating at the point where short run average costs are minimized – As can be seen in the previous graph, Plant A’s short-run average cost is minimized at Point M, but at that output level, Plant B is more efficient in that it has lower short-run average costs. -In general, when economies of scale are present, the least-cost plant will operate at less than full capacity -Capacity refers to the point at which short-run average costs are minimized -Only for that single output level at which long-run average cost is minimized (Q*) is the optimal plant operating at the minimum point on its short run average cost curve Minimum Efficient Scale