Technical Efficiency and
Economic Efficiency
• When choosing among existing technologies in the long
run, (or short run?) firms are interested in the lowest
cost methods of production
• Technical efficiency in production means that as few
inputs as possible are used to produce a given output
• The economically efficient method of production is
the method that produces a given level of output at
the lowest possible cost.
• It is the least-cost technically efficient process
Economies of Scale
More efficient as size increases
Diseconomies of Scale
Less efficient as size increases
Constant Returns to Scale
Efficient Range of Production
A Typical Long-Run Average
Total Cost Table
Q
TC of Labor
($)
TC of Machines
($)
TC ($)
ATC ($)
11
381
254
635
58
12
390
260
650
54
13
402
268
670
52
14
420
280
700
50
15
450
300
750
50
16
480
320
800
50
17
510
340
850
50
18
549
366
915
51
19
600
400
1000
53
20
666
444
1110
56
ATC falls
because of
economies of
scale
ATC is constant
because of
constant
returns to scale
ATC rises
because of
diseconomies
of scale
A Typical Long-Run Average
Total Cost Curve
Costs
per unit
$60
$55
Minimum
efficient
level of
production
Long-run
average total
cost (LRATC)
$50
Q
11
14
17
20
ATC falls because
ATC rises because
ATC is constant
of economies
because of constant of diseconomies
of scale
of scale
returns to scale
Economies of Scale
long-run average total costs decrease as output increases
• Indivisible setup cost is the cost of an input
for which a certain minimum amount of
production must be undertaken before the
input becomes economically feasible to use
• Indivisible setup costs create many realworld economies of scale
• The cost of a blast furnace or an oil refinery
is an example of an indivisible setup cost
• The minimum efficient level of production
is the amount of production that spreads
setup costs out sufficiently for firms to
undertake production profitably
• reached once the size of the market expands to a
size large enough for firms to take advantage of
all economies of scale
$60
Minimum
efficient
level of
production
$55
$50
11
14
17
20
Q
Constant Returns to Scale
• the flat portion of the curve
• when average total costs do not change
as output increases
• when production techniques can be replicated
again and again to increase output
• before monitoring costs rise and team
spirit is lost
Diseconomies of Scale
• when long-run average total costs increase
as output increases
• These are shown by the upward sloping portion of the
long-run average total cost curve
• Usually, but not always, start occurring
as firms get large
Two reasons for diseconomies of scale are:
1. Increased monitoring costs (the costs
incurred by the organizer of production in
seeing to it that the employees do what
they’re supposed to do)
2. Loss of team spirit (the feelings of
friendship and being part of a team that
bring out people’s best efforts)
Gets more efficient Efficient Range
as size increases
of Production
Gets less efficient
as size increases
LRAC
60,000
Economies
of Scale
50,000
40,000
Diseconomies
of Scale
30,000
20,000
Constant Returns
to Scale
10,000
0
1
2
3
4
5
6
7
8
9
10
Hundred thousand Cars
1. Which of the following is most likely to be an implicit cost of
production?
a. property taxes on a building owned by the firm
b. transportation costs paid to a trucking supplier
c. rental payments for a building utilized by the company and rented from
another party
d. interest income foregone on funds invested in the firm by the owners
2. The law of diminishing returns
a. explains why marginal cost eventually increases as output expands.
b. implies that average fixed cost will remain unchanged as output expands.
c. is true for physical production activities but not for activities such as studying.
d. applies to a capitalist economy but would be irrelevant if the means of
production were owned by the state.
3. Which of the following represents a long-run adjustment?
a. the hiring of four additional cashiers by a supermarket
b. a cutback on purchases of coke and iron ore by a steel manufacturer
c. construction of a new assembly-line plant by a car manufacturer
d. the extra dose of fertilizer used by a farmer on his wheat crop
4. The short-run average total cost (ATC) curve of a firm is U-shaped because
a. larger firms always have lower per-unit costs than smaller firms.
b. at low levels of output, AFC will be high, while at high levels of output, MC will be
high as the result of diminishing returns.
c. diminishing returns will be present when output is small, and high AFC will push
per-unit cost to high levels when output is large.
d. diseconomies of scale will be present at both small and large output rates.
5. When costs that vary with the level of output are divided by the output, you
have calculated
a. total changing cost.
b.
total fixed cost.
c. average fixed cost.
d.
average variable cost.
6. A downward-sloping portion of a LR average total cost curve is the result of
a. economies of scale.
b.
diseconomies of scale.
c. diminishing returns.
d.
the existence of fixed resources.
7. In the short run, if average variable cost equals $50, average total cost equals
$75, and output equals 100, the total fixed cost must be
a. $25.
b. $2,500.
c. $5,000.
d.
$7,500.
At what output in the graph would the
firm’s per-unit cost of production be
minimized?
b. 4
a. 3
c. 5
d. 6
What is the firm’s approximate total
cost when it produces three units?
c. 48
a. 10
b. 16
d. 60
What is the firm’s total cost when it produces four units?
c. 60
a. 11
b. 15
d. 75
The average variable cost and average total cost
for a firm are indicated in the graph. If the
marginal cost curve were constructed, at what
output would it cross the AVC curve?
b. 15
a. 10
c. 20
d. 25
At what output should a the marginal
cost curve cross the ATC curve?
a. 15
b. 20
c. 25
d. 30