no return to look at production and costs in the long run and remember the long run was defined as the period over which all inputs all factors are variable so the The Firm can freely choose how much labor and capital it uses in the long run scenario in the long run all inputs are variable and firms make decisions regarding the scale of their production decide whether higher levels of production would lead to Greater efficiency they make decisions on the location of their operations with some locations lead to lower costs than others and in their techniques of production do they use for instance Capital intensive methods or labor intensive when thinking about the scale of production for a firm a firm needs to understand what happens to its output level if it changes its skill if it's scales up or scales down its production process for example if it scales upwards production and facility by increasing all its inputs by the same factor say for example it doubles all its inputs will output increase by the CM amount the same factor will a double will it increase by less or will it increase by more in other words it's interested in the form of the returns to scale we say that it a firm's production adheres to constant returns to scale in the case where if we increase inputs by some Factor output increases by exactly the same factor so if we double all inputs output for example exactly doubles a firm faces increase in returns to scale if when you increase all inputs by a certain Factor output increases by more than that factor so if we doubled all inputs output would more than double and you have decreasing returns to scale in the case where if you increase all your inputs by a certain Factor output increases by less than that factor so by doubling all inputs output less than doubles the returns to scale describe a production relationship we're only talking about the units of inputs change in in our production process and looking at what the effect of that will be on output we haven't yet brought in the idea of costs into this framework so it returns to scale related to efficiencies in production if we take in the cost of inputs and per count and we're dealing with economies of scale and diseconomies of scale economies or diseconomies of scale include factors related to production efficiency returns to scale and the cost or expenditure on inputs economies of scale occur when the firm increases its output the average cost of production declines and the sources of economies of scale include specialization and division of labor the ability in larger work units for individuals to specialize in a task become very good at them and become more productive so if each worker can produce more it means that the average cost of production will detain indivisibilities in terms of inputs being used if we have to pay for a machine the average cost of production will decline as we increase our number of units if we only produce one unit using the machine we still have to pay for that whole machine if we can you produce a thousand units the cost of the machine did not change but the average cost of the output the cost of production divided by the number of units has declined foreign we have other sources of economies of scale the container principle greater efficiency of large machines organizational economies Financial economies and so on and you're directed to the textbooks that are online to go and investigate what each of these is and try to understand how they reflect in terms of a diminishing average cost this economies of scale are associated with very large firms so as a firm increases at scale the diseconomies May set in which are associated with higher average costs of production this economies of scale are often attributed to the difficulties of managerial control of a very large Enterprise as firms become bigger managers may find it more difficult to ensure efficiency in all aspects of operation they're not as acutely aware of what's happening in every part of the firm if workers feel alienated from the management then they may lose motivation if their jobs become boring or repetitive because they're specializing so much in a particular task again motivation can suffer and they may become less productive industrial relations can suffer in a very large form where workers feel alienated all of those things lead to lower productivity of workers or the other side of that is it leads to a higher average cost of production of output firms also in the long run make decisions about their location or whether to relocate their Enterprises in the long run a firm can change its location in order to minimize its costs and one of the main costs associated with location decisions are the transport costs associated with bringing inputs into the Enterprise and transport costs of final output to the market so the kinds of decisions they need to make are do we locate near the market for produce have lower costs of of transport to the market do we locate nearer our source of raw materials the costs of transport of raw materials relative to the final produce will be a factor that influences this decision foreign The Firm can pay attention to its technique of production in the long run we said all inputs are variable which means that the firm can choose its technique does it want to be highly automated a capital intensive process or does it want to choose labor-intensive techniques and the technique that it chooses will depend will influence sorry the costs of production so whatever is the cheaper cost will determine the technique that will be used to produce its output The Firm chooses the optimum or cost minimizing mix of inputs The Firm will alter the mix of Labor and capital used in production if the factor prices change so if labor becomes more expensive if wage rates rise we might see the firms choosing a more Capital intensive production method if that's possible for their technology in production if we just decline then the firm may go for a more labor-intensive method of production when the firm is deciding on its least cost combination of Labor and capital to use in its production process it will set the combination as a point where the marginal physical product of labor over the price of Labor equals the marginal physical product of capital over the price of capital it will chase a combination of Labor and capital where the last Euro spent on either capital or labor yields the same change in output if that didn't hold if there was an inequality between the two suppose the marginal physical product of labor over the price of Labor is greater than the marginal physical product of capital over the price of capital in that case adding one more Euro expenditure on labor gives more in terms of output than you would lose by reducing your expenditure on Capital by one euro so if you're in a scenario where that inequality holds the firm should use more labor and less capital by switching one year of expenditure from Capital to labor output would increase by the difference in the two values mppl over PL minus mppk over PK if we have many factors of production then the rule for how much of each factor you would use is to choose the combination so that the marginal physical product of the factor divided by its price is equal among all factors so the last Euro spent in any factor of production yields the same change in output now because we're looking at long run costs using that role as a way of choosing the combination of inputs means that the firm the manager would need to know the future Factor prices to be able to ensure that this row holds in the longer term if we have a change in any one price or a marginal product of a factor this will result in changed use of all the factors of production so we've talked about the scale of production location decisions the input combinations to use in the long run we've talked about the production side in the long run how does that transfer into the cost site for the firm in the long run production so costs in the long run were all factors of production can be changed in the long run all costs are variable we can vary every factor of production so there's no fixed cost in the long run the fixed cost in the short run was because one factor of production was in fixed availability to us and we had to pay for that factor whether or not we used it in the long run all factors are variable which means that all costs are variable the long run average cost may show economies of scale and operation where the long run average cost is Fallen does economies of scale or long run average cost Rises or neither economies nor diseconomies of scale or long-run average cost is constant and it's often assumed that as a firm expands at first experiences economies of scale than it experiences constant costs and finally diseconomies of scale set in so at first average cost would fall then is constant and then average costs increase as the firm expands its production so setting up the long run average cost for a firm we have cost on the vertical axis output produced on the horizontal axis over the range of output where economies of scale exist average cost will fall then we have a range of output where we experience constant costs and as the firm becomes larger as it scales up production to a larger scale in the long run this economies of scale set in associated with increasing average costs so the long run average cost curve is a saucer-shaped function this assumes that factor prices and quality are given technology doesn't change and that the firms are choosing the cheapest production method the cheapest combination of capital and labor at every output level when we have a case where the long run average cost is Fallen associated with economies of scale so as output increases average cost Falls it must be the case that the marginal cost of production is below the average cost the only way the average value can come down is if each extra unit of output costs less than average in order to produce foreign where the long run average cost is increasing as output increases this must be associated with a long-run marginal cost lying above the average cost so the only way that the average can increase is if each extra unit of output costs more than average in order to produce it and finally if we have a constant average cost of long run average costs are constant then the long run marginal cost must be equal to the long run average cost if the marginal cost is above average cost average cost would be rising if marginal costs were below average cost average cost would be fallen so the only way average costs can be constant is if each extra unit of output costs just the average cost to produce so showing our long run average cost the shallow u-shaped average cost function its average cost is declining where you have economies of scale when this economies of scale set in at higher levels of output average costs start to increase again as average cost declines marginal cost must be below it as average cost Rises marginal cost is above it so the long run marginal cost cuts the long run average cost at its minimum point so we've identified the cost structure for a firm in both the short run and the long run we have talked about the total cost the average cost the marginal cost in each case so we've got a picture of the costs associated with production next we're going to look at the revenues facing a firm and then we'll be able to bring the revenue and the cost site together to look for the profit maximizing output of a firm