19/01/16
Lesson 3: Cost Theory-Long Run
Learning Objective: I can define and explain the concept of "economies of scale".
DA: All planning takes place in which period, short or long run?
The Long Run: When planning is in the long run, an entrepreneur is free to adjust the quantity of all of the factors of production that are used and is only restrained by the current level of technology.
This means that in the long-run, we look at what happens to costs when all of the factors of production are increased in order to increase output.
DA: All planning takes place in which period, short or long run?
The Long Run: When planning is in the long run, an entrepreneur is free to adjust the quantity of all of the factors of production that are used and is only restrained by the current level of technology.
This means that in the long-run, we look at what happens to costs when all of the factors of production are increased in order to increase output.
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Economies of Scale: Economies of scale are any decreases in LRAC that come about when a firm alters all of its factors of production in order to increase its scale of output. Economies of scale lead to the firm experiencing increasing returns to scale.
The following are all different economies of scale that may benefit a firm as it increases the scale of its output:
Activity: Looking at the scenario from lesson 1 from this chapter, if demand for the burger continues to be strong, and Herson is facing diminishing marginal returns, what should be his strategy in terms of the long run?
Ex. Young entrepreneur named Herson sets up a new business, a small hamburger stand on calle hambre. His business currently the following fixed factors of production: refrigerator, hamburger cart w/ three grills, menu board, and five tables w/ twenty chairs. He can make 20 burgers per hour. Demand increases so he decides increase his labor by hiring additional employees:
The following are all different economies of scale that may benefit a firm as it increases the scale of its output:
- Specialization: As firms grow they are able to have their management specialize in individual areas of expertise, such as production, finance, or marketing, thus be more efficient.
- Division of labor: Breaking a production process down into small activities that workers can perform repeatedly and efficiently. A good example would be workers on assembly lines.
- Bulk buying: As firms increase in scale they are often able to negotiate discounts with their suppliers that they would not have received when they were smaller. Cost of their inputs are reduced, which reduces unit costs of production.
- Financial economies: Large firms can raise financial capital more cheaply than small firms. Greater confidence from the banks.
- Transport economies: Large firms making bulk orders may be charged less for delivery costs than smaller firms.
- Large machines: Some machinery is too large to be owned and used by a small producer, instead of owning the physical capital, the smaller firm has to rent.
- Promotional economies: Firms attempt to promote their products using advertising. This costs does not increase as much as output, ie, if a firm doubles its output then it's unlikely that it will double its expenditure on promotion. Thus the cost of promotion per unit of output falls.
- Control and communication problems: As a firm grows in scale, management will find it harder to control and coordinate the activities of the firm, leading to inefficiencies and increases in the unit costs of production.
- Alienation and loss of identity: As firms grow it is possible for the workers/managers to feel that they are only a very small part of a very big organization.
- External economies/diseconomies of scale relates to entire industries. You could also relate this to macroeconomics.
Activity: Looking at the scenario from lesson 1 from this chapter, if demand for the burger continues to be strong, and Herson is facing diminishing marginal returns, what should be his strategy in terms of the long run?
Ex. Young entrepreneur named Herson sets up a new business, a small hamburger stand on calle hambre. His business currently the following fixed factors of production: refrigerator, hamburger cart w/ three grills, menu board, and five tables w/ twenty chairs. He can make 20 burgers per hour. Demand increases so he decides increase his labor by hiring additional employees:
- Eliana = Increase TP to 50 burgers per hour.
- Andres = Increase TP to 90 burgers per hour.
- Carlota = Increase TP to 124 burgers per hour.