Lecture Notes: Long-Run Production and Costs

Key Concepts

• Long Run: Period over which all inputs are variable.
• Firms can freely choose labor and capital amounts.
• Decisions are made on:
  • Scale of production
  • Location of operations
  • Techniques of production (Capital vs. Labor intensive)

Scale of Production

• Firms analyze changes in output relative to changes in input scale.
• Returns to Scale:
  • Constant Returns: Inputs increase by a factor, output increases by the same factor.
  • Increasing Returns: Inputs increase by a factor, output increases by more.
  • Decreasing Returns: Inputs increase by a factor, output increases by less.

Economies and Diseconomies of Scale

• Economies of Scale:
  • Occur when average costs decline as output increases.
  • Sources include specialization, division of labor, and indivisibilities.
• Diseconomies of Scale:
  • Occur when average costs increase with large-scale production.
  • Common causes include managerial inefficiencies, worker alienation.

Location Decisions

• Consideration of transport costs for inputs and outputs.
• Decisions include proximity to markets or sources of raw materials.

Techniques of Production

• Firms choose tech based on cost efficiency (capital vs. labor intensive).
• Optimum Mix of Inputs:
  • Decision based on marginal physical product divided by input price.
  • Adjust according to changes in factor prices.

Costs in the Long Run

• All costs are variable; no fixed costs.
• Long-run average cost (LRAC) curve:
  • Economies of scale: falling LRAC
  • Constant costs
  • Diseconomies of scale: rising LRAC
• LRMC and LRAC relationship:
  • Falling LRAC: LRMC < LRAC
  • Rising LRAC: LRMC > LRAC
  • Constant LRAC: LRMC = LRAC

Conclusion

• Long run involves planning for variable factors.
• Understanding cost structures (total, average, marginal) is crucial.
• Next steps include analyzing revenues and profit-maximizing outputs.