PAC - Graphing the Long Run Lesson

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Graphing the Long Run Lesson

Remember, in the long run, the firm can change the levels of all resources used in production. This means capital can change in the long run. Capital expansion can reduce costs for the firm in the long run by delaying the onset of diminishing returns in the production function. To reach productive efficiency, a firm will choose to produce at the minimum ATC. As capital is expanded, firms experience changes in their short run average total cost (SRATC) curves. A series of SRATCs is created, each representing a different level of capital being employed by a firm. The long run average total cost (LRATC) curve for a firm is derived by selecting the lowest SRATC for given level of output the firm wishes to produce.

Long Run Average Total Cost Curve (LRATC)

Long Run Average Total Cost (LRATC) Curve X-axis – Quantity Y-axis - Costs If the firm chooses to produce Q1 units, it can so so using SRATC1 (1 unit of capital) or SRATC2 (2 units of capital). In this case, it would choose to produce with SRATC2 because costs are lowest with that amount of capital for the quantity the firm will produce. If the firm chooses to produce at Q3 units, it can do so using SRATC2 (2 units of capital) or SRATC3 (3 units of capital). In this case, it would choose to produce with SRATC3 because costs are lowest with that amount of capital for the quantity the firm would like to produce. LRATC is formed by encompassing the lowest portions of each SRATC for a given level of output.

Long Run Average Total Cost (LRATC) Curve Scale

Long Run Average Total Cost Curve Scale (LRATC Scales Curve) X-axis – Quantity of Output Y-axis - Costs The graph shows a curve for LRATC. “Economies of Scale” is labeled between 0 and point MES on the x-axis. “Constant Returns to Scale” is in the middle of the curve. “Diseconomies of Scale” is toward the end of the curve past a second unlabeled point.

Long Run Average Total Cost Video

View the video for explanations on the long run ATC curve and economies/diseconomies of scale. To make the video full screen, click the double arrows at the bottom right corner of the object.

LSR Curves Graphs A, B, and C

LSR Curves Graphs A, B, and C Graph A – Constant Cost (LRS) X-axis – Quantity Y-axis – Price Graph B – Increasing Cost (LRS) X-axis – Quantity Y-axis – Price Graph C – Decreasing Cost (LRS) X-axis – Quantity Y-axis – Price Each graph contains different curves for D1, D2 and S1, S2. Points Q1 and Q2 are on the x-axis. In each graph, the curves change.

The graphs above explain how the long run industry supply curve is impacted by external economies of scale, constant returns to scale, and diseconomies of scale. In graph A, the long run supply curve is horizontal. This is due to costs at the firms in this industry remaining constant as the industry expands (the shift in demand is met by an equal increase in supply). Because costs do not change, the shifts in the market demand and supply curves are equal. In graph B, the long run industry supply curve is upward sloping. This is due to costs at the firms in this industry increasing as the industry expands (the shift in demand is greater than the corresponding shift in supply). Finally, in graph C, the long run industry supply curve is downward sloping. This is due to costs at the firms in this industry decreasing as the industry expands (the shift in demand is less than the corresponding shift in supply).

To really understand this, you need to keep in mind that firms enter or exit markets because of profits. As costs increase, profit at any given firm is smaller, so there is less incentive for firms to enter this market (and fewer firms will do so) and supply will not shift as much. As costs decrease, profit at any given firm is greater, so there is more incentive for firms to enter this market (and more firms will do so) and supply will shift more. 

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IMAGES CREATED BY GAVS