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LECTURE 6: VARIOUS MEASURES OF COSTS
Learning Outcomes
By the end of the lecture, students should be able to


Relate the various measures of short-run costs with the
,long-run costs and their differences



Evaluate why the long-run average costs curve has a
U-shape
...

The average cost and marginal cost in the long run are U shaped due to different effects of returns
to scale at different levels of outputs
...
Hence,
TC = VC



The law of diminishing marginal returns does not
occur in the long-run because the firm is able
to change all inputs and hence does not
influence the long-run costs curve
...

This is because each plant has its own short-run
costs;
Long-run is also the planning period for a firm
...


AVERAGE COSTS AND MARGINAL COSTS IN THE
LONG-RUN
Long-run average cost is known as the planning
curve because it depicts growth path that can be
followed by the firm only in the long-run
...


Figure

1

FIGURE 1: LONG-RUN AVERAGE COST CURVE AND
LONG-RUN MARGINAL COST CURVE
Stage 1: Increasing return to scale or economies
of scale (Q1)
Stage 2: Constant returns to scale (Q1 – Q2)
Stage 3: Diseconomies of scale (after Q2)

 Figure

1: Long-run average cost curve and
long-run marginal cost curve

TC

LTC

Q1

Q2

QTY

LMC LAC

Q1

Q2

QTY

ECONOMIES OF SCALE: FACTORS INFLUENCING
DECLINE OF LAC



Labour specilaisation – can be increased when
the size of the plant increases
...


Efficiency of Management: can be
achieved when the size of the plant
increases and managers can increase
efficiency by managing more workers
and more materials
...



Efficiency of Equipment Usage

When the size of the plant increases, usage of
capacity can be increased
...


 Figure

5: Long-run total cost curve and
average cost curve for economies of scale

TOTAL COST
LTC

MC

QTY

AC LAC

LMC

QTY

DISECONOMIES OF SCALE


Can be caused by decreasing returns to scale
or other factors which includes:



Inefficiency of management that might be
caused by increase in bureaucracy, or
excessive burden to the management
...
This causes the input price
to increase due to competition
...

The LAC is horizontal
...

Long-run cost and short-run cost must be equal
on at least one level of output
...


The long –run cost curve is the envelope
for short-run cost curve, i
...
each point on
the long-run cost curve is the tangent to
a point on a short-run cost curve
...




The LRAC is derived by a series of short run
average cost curves (SAC)
...
But the average cost will
increase from point A to point B
...
But the average cost will
increase from point A to point B
...


FIGURE 13: LONG-RUN COSTS CURVE OF CONSTANT ECONOMIES OF
SCALE

LONG-RUM MARGINAL COSTS AND SHORT-RUN
MARGINAL COSTS
Long-run Marginal Cost (LMC) is equivalent to Short-run
Marginal Cost (SMC) when Long-Run Average Cost (LAC)
is equivalent to Short-Run Average Cost (SAC) and when
LTC =STC
...


Output

AC1

AC2

AC3

10

7

17

53

20

5

13

44

30

5

9

35

40

4

6

27

50

5

4

20

60

7

3

14

70

10

4

11

A FIRM HAS 3 SIZES OF PLANT WITH
AVERAGE COST OF EACH PLANT SHOWN
ABOVE
...


EXERCISE
1
...


Distinguish between fixed costs and variable costs
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Explain the relationship between marginal cost
and average cost with a suitable diagram
...
Distinguish between implicit cost and explicit
cost
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With the aid of diagram, explain the short-run
cost curves

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