1. RET PA HC 8
Costs and Output Decisions in
the Long Run
Prepared by: Fernando Quijano
and Yvonn Quijano
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

2. The Concept of Profit
• Profit is the difference between total revenue
and total cost.
• The economic concept of profit takes into
account the opportunity cost of capital.
• Total economic cost includes a normal rate of
return. A normal rate of return is the rate that is
just sufficient to keep current investors interested
in the industry.
• Breaking even is a situation in which a firm is
earning exactly a normal rate of return.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

3. The Long-Run Average Cost Curve
• The long-run average cost
curve (LRAC) is a graph that
shows the different scales on
which a firm can choose to
operate in the long-run. Each
scale of operation defines a
different short-run.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

4. The Long-Run Average Cost Curve
• The long run average cost curve of a firm
exhibiting economies of scale is downward-
sloping.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

5. Weekly Costs Showing Economies of
Scale in Egg Production
JONES FARM TOTAL WEEKLY COSTS
15 hours of labor (implicit value $8 per hour) $120
Feed, other variable costs 25
Transport costs 15
Land and capital costs attributable to egg production 17
$177
Total output 2,400 eggs
Average cost $.074 per egg
CHICKEN LITTLE EGG FARMS INC. TOTAL WEEKLY COSTS
Labor $ 5,128
Feed, other variable costs 4,115
Transport costs 2,431
Land and capital costs 19,230
$30,904
Total output 1,600,000 eggs
Average cost $.019 per egg
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

6. A Firm Exhibiting Economies and
Diseconomies of Scale
• The long-run average cost curve of a firm
that eventually exhibits diseconomies of
scale becomes upward-sloping.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

7. Optimal Scale of Plant
• The optimal scale of plant is the scale that
minimizes average cost.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

8. Internal Versus External
Economies of Scale
• Economies of scale that are found
within the individual firm are called
internal economies of scale.
• External economies of scale
describe economies or diseconomies
of scale on an industry-wide basis.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

9. Long-Run Costs: Economies and
Diseconomies of Scale
• Increasing returns to scale, or
economies of scale, refers to an
increase in a firm’s scale of
production, which leads to lower
average costs per unit produced.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

10. Long-Run Costs: Economies and
Diseconomies of Scale
• Constant returns to scale refers to
an increase in a firm’s scale of
production, which has no effect on
average costs per unit produced.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair

11. Long-Run Costs: Economies and
Diseconomies of Scale
• Decreasing returns to scale refers
to an increase in a firm’s scale of
production, which leads to higher
average costs per unit produced.
© 2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair