Technical Efficiency and Economic Efficiency

• Technical efficiency in production means that as few inputs as possible are used to produce a given output

• When choosing among existing technologies in the long run, (or short run?) firms are interested

in the lowest cost methods of production

• 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

Less efficient as size increases

More efficient as size increasesDiseconomies of Scale

Constant Returns to ScaleEfficient Range of Production

A Typical Long-Run Average Total Cost Table

QTC 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 scaleATC rises

because of diseconomies of scale

A Typical Long-Run Average Total Cost Curve

Q

Costs per unit

11

$50

$55

17

$60

14 20

Long-run average

total cost (LRATC)

ATC falls because of

economies of scale

ATC is constant because of

constant returns to scale

ATC rises because of

diseconomies of scale

Minimum efficient level of

production

Economies of Scale

• 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

• The cost of a blast furnace or an oil refinery is an example of an indivisible

setup cost

long-run average total costs decrease as output increases

• Indivisible setup costs create many real-world economies of scale

• 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

Q11

$50

$55

17

$60

14 20

Minimum efficient level of

production

Constant Returns to Scale• the flat portion of the curve

• when production techniques can be replicated again and again to increase

output

• when average total costs do not change as output increases

• before monitoring costs rise and team spirit is lost

Diseconomies of Scale

• Usually, but not always, start occurring as firms get large

• 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

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)

LRAC

Hundred thousand Cars

60,000

50,000

40,000

30,000

20,000

10,000

1 2 3 4 5 60 7 8 9 10

Constant Returns to

Scale

Diseconomies of Scale

Economies of Scale

Gets less efficient as size

increases

Gets more efficient as size increases

Efficient Range of Production

1. Which of the following is most likely to be an implicit cost of production?

a. property taxes on a building owned by the firmb. transportation costs paid to a trucking supplierc. rental payments for a building utilized by the company and rented

from another partyd. interest income foregone on funds invested in the firm by the

owners

2. The law of diminishing returnsa. 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 supermarketb. a cutback on purchases of coke and iron ore by a steel manufacturerc. construction of a new assembly-line plant by a car manufacturerd. 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 becausea. 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?a.3 b. 4 c. 5 d. 6What is the firm’s approximate total cost when it produces three units?a.10 b. 16 c. 48 d. 60

What is the firm’s total cost when it produces four units?a.11 b. 15 c. 60 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?a. 10 b. 15 c. 20 d.

25At what output should a the marginal cost curve cross the ATC curve?a. 15 b. 20 c. 25 d.

30

b. 4

c. 48

c. 60

b. 15

b. 20