Page 604 - Krugmans Economics for AP Text Book_Neat

We can now draw the distinction between the short run and the long run more fully.
In the long run, when a producer has had time to choose the fixed cost appropriate for
its desired level of output, that producer will be at some point on the long-run average
total cost curve. But if the output level is altered, the firm will no longer be on its long-
run average total cost curve and will instead be moving along its current short-run av-
erage total cost curve. It will not be on its long-run average total cost curve again until
it readjusts its fixed cost for its new output level.
Figure 56.2 illustrates this point. The curve ATC 3 shows short-run average total cost if
Selena has chosen the level of fixed cost that minimizes average total cost at an output of 3
cases of salsa per day. This is confirmed by the fact that at 3 cases per day, ATC 3 touches
LRATC, the long-run average total cost curve. Similarly, ATC 6 shows short-run average total
cost if Selena has chosen the level of fixed cost that minimizes average total cost if her out-
put is 6 cases per day. It touches LRATC at 6 cases per day. And ATC 9 shows short-run aver-
age total cost if Selena has chosen the level of fixed cost that minimizes average total cost if
her output is 9 cases per day. It touches LRATC at 9 cases per day.
Suppose that Selena initially chose to be on ATC 6 . If she actually produces 6 cases of
salsa per day, her firm will be at point C on both its short-run and long-run average total
cost curves. Suppose, however, that Selena ends up producing only 3 cases of salsa per day.
In the short run, her average total cost is indicated by point B on ATC 6 ; it is no longer on
LRATC. If Selena had known that she would be producing only 3 cases per day, she would
have been better off choosing a lower level of fixed cost, the one corresponding to ATC 3 ,
thereby achieving a lower average total cost. Then her firm would have found itself at
point A on the long-run average total cost curve, which lies below point B.
Suppose, conversely, that Selena ends up producing 9 cases per day even though
she initially chose to be on ATC 6 . In the short run her average total cost is indi-
cated by point Y on ATC 6 . But she would be better off purchasing more equip-
ment and incurring a higher fixed cost in order to reduce her variable cost
and move to ATC 9 . This would allow her to reach point X on the long-run
average total cost curve, which lies below Y. The distinction between short-
run and long-run average total costs is extremely important in making
sense of how real firms operate over time. A company that has to increase
Photodisc output suddenly to meet a surge in demand will typically find that in the short
run its average total cost rises sharply because it is hard to get extra production out of
existing facilities. But given time to build new factories or add machinery, short-run av-
erage total cost falls.

Returns to Scale
What determines the shape of the long-run average total cost curve? It is the influence of
scale, the size of a firm’s operations, on its long-run average total cost of production. Firms
that experience scale effects in production find that their long-run average total cost
changes substantially depending on the quantity of output they produce. There are
economies of scale when long-run average total cost declines as output increases. As you
can see in Figure 56.2, Selena’s Gourmet Salsas experiences economies of scale over output
levels ranging from 0 up to 6 cases of salsa per day—the output levels over which the long-
There are economies of scale when
long-run average total cost declines as output run average total cost curve is declining. Economies of scale can result from increasing re-
increases. turns to scale, which exist when output increases more than in proportion to an increase
in all inputs. For example, if Selena could double all of her inputs and make more than
There are increasing returns to scale
when output increases more than in twice as much salsa, she would be experiencing increasing returns to scale. With twice the
proportion to an increase in all inputs. For inputs (and costs) and more than twice the salsa, she would be enjoying decreasing long-
example, with increasing returns to scale, run average total costs, and thus economies of scale. Increasing returns to scale therefore
doubling all inputs would cause output to imply economies of scale, although economies of scale exist whenever long-run average
more than double. total cost is falling, whether or not all inputs are increasing by the same proportion.
There are diseconomies of scale when In contrast, there are diseconomies of scale when long-run average total cost in-
long-run average total cost increases as creases as output increases. For Selena’s Gourmet Salsas, decreasing returns to scale
output increases. occur at output levels greater than 6 cases, the output levels over which its long-run

562 section 10 Behind the Supply Curve: Profit, Production, and Costs