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11.5 Cost Curves: Short Run Versus Long Run

Over long enough time periods, firms can vary all of their productive inputs. However, in the short run, a company cannot vary its plant size and equipment. They are fixed in the short run, so the firm can only expand output by employing more variable inputs.

The LRATC curve is equal to or below the SRATC curves. In the long run, costs are lower because firms have greater flexibility n changing their inputs that are fixed in the short run.

As the firm moves along the LRATC, the factory size changes with the quantity of output.

Exhibit 1: Short- and Long-Run Average Total Cost

When ATC falls as output expands, economies of scale are present. When the ATC does not vary with output, the firm is facing constant returns to scale. When the ATC rises as output expands, the firm is facing diseconomies of scale.

The typical firm may experience economies of scale at low levels of output, constant returns to scale at higher levels of output, and diseconomies of scale at still higher levels of output. At the minimum efficient scale, a plant has exhausted its economies of scale and the long-run average total cost is minimized.

Economies of scale may exist because a firm can use mass production techniques or capture gains from further labor specialization not possible at lower levels of output. Diseconomies of scale may occur as a firm finds it increasingly difficult to handle the complexities of large-scale management.

In the News: The Cost Revolution


Appendix: Using Isoquants and Isocosts


Chapter 12: Firms in Perfectly Competitive Markets


12.1 A Perfectly Competitive Market

Perfect competition is characterized by (1) many buyers and sellers, (2) identical (homogeneous) products, and (3) easy market entry and exit.

With many buyers and sellers, each firm is so small in relation to the industry, its production decisions have no impact on the market, so each firm regards price as something over which they have little control.

Consumers believe that all firms in a perfectly competitive market sell identical (homogeneous) products, so that the products of all the firms are perfect substitutes.

Product markets characterized by perfect competition have no significant barriers to entry or exit. This means that it is fairly easy for entrepreneurs to become suppliers of the product or, if they are already producers, to stop supplying the product. The barriers to entering the business are modest, so that large numbers of firms can overcome the barriers and enter the business if they so desire. Because of easy market entry and exit, perfectly competitive markets generally consist of a large number of small suppliers.

A perfectly competitive market is approximated most closely in highly organized markets for securities and agricultural commodities.

Although all the assumptions for perfect competition are seldom met, the model of perfect competition is useful because there are many markets that resemble perfect competition in that firms face very elastic demand curves and relatively easy entry and exit. It also gives us a standard of comparison.