Output and Costs

Sessions 11-12:
Production and cost in the long run
 Long-Run Cost (all inputs vary)
• The behaviour of long-run cost depends on the firm’s production function,
which is the relationship between the maximum output attainable and the
quantities of all the factors of production.
The Production Function

• The table shows the total product data for four quantities of capital
(factory sizes)

2 Economics 2ed: Global and Southern African Perspectives © 2013

 Long-Run Cost
• The greater the factory size, the larger is the output produced by any given
quantity of labour
• For a given factory size, the marginal product of labour diminishes as more
labour is employed
• For a given quantity of labour, the marginal product of capital diminishes as
the quantity of capital used increases

Diminishing Returns
• Diminishing returns occur as the quantity of labour increases for a given
factory size

Short-Run Cost and Long-Run Cost

• The minimum average total cost for a larger factory occurs at a greater
output than it does for a smaller factory because the larger factory has a
higher total fixed cost and therefore, for any given output, a higher average
fixed cost

3 Economics 2ed: Global and Southern African Perspectives © 2013

 Long-Run Cost

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 Economies and Diseconomies of Scale
• Economies of scale are features of a firm’s technology that make average
total cost fall as output increases. If inputs go up by x%, output goes up by
more than x% (e.g. inputs go up by 20%, output goes up by 30%).
• When economies of scale are present, the LRAC curve slopes downward

• Diseconomies of scale are features of a firm’s technology that make average

total cost rise as output increases. If inputs go up by x%, output goes up by
less than x%. (e.g. inputs go up by 20%, output goes up by 10%). LAC
slopes upward.

• When diseconomies of scale are present, the LRAC curve slopes upward
• It is possible to get constant returns to scale. Inputs go up by x% and
output goes up also by x%. (e.g. inputs go up by 20%, output goes up by
20%). LAC is flat.

6 Economics 2ed: Global and Southern African Perspectives © 2013

 Minimum Efficient Scale

• A firm’s minimum efficient scale is the smallest output at which long-run average
cost reaches its lowest level.

• MES = a special, lowest point of TC/Q

• Output needed to achieve MES is largely dependent on capital intensity. Compare

MES of a fruit seller to that of an electricity generator!

• The larger the MES in relation to demand (MES/market size), the fewer firms are
expected to be in a given industry. There is only one Eskom but thousands of fruit
and veg sellers.

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End of Part 3