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The relationship between the quantity at the minimum of the long-run average cost curve and the quantity demanded in the market at that price will predict how much competition is likely to exist in the market. If the quantity demanded in the market far exceeds the quantity at the minimum of the LRAC, then many firms will compete. If the quantity demanded in the market is only slightly higher than the quantity at the minimum of the LRAC, a few firms will compete. If the quantity demanded in the market is less than the quantity at the minimum of the LRAC, a single-producer monopoly is a likely outcome.

Shifting patterns of long-run average cost

New developments in production technology can shift the long-run average cost curve in ways that can alter the size distribution of firms in an industry.

For much of the twentieth century, the most common change has been to see alterations in technology, like the assembly line or the large department store, where large-scale producers seemed to gain an advantage over smaller ones. In the long-run average cost curve, the downward-sloping economies of scale portion of the curve stretched over a larger quantity of output.

However, new production technologies do not inevitably lead to a greater average size for firms. For example, in recent years some new technologies for generating electricity on a smaller scale have appeared. The traditional coal-burning electricity plants needed to produce 300 to 600 megawatts of power to exploit economies of scale fully. However, high-efficiency turbines to produce electricity from burning natural gas can produce electricity at a competitive price while producing a smaller quantity of 100 megawatts or less. These new technologies create the possibility for smaller companies or plants to generate electricity as efficiently as large ones. Another example of a technology-driven shift to smaller plants may be taking place in the tire industry. A traditional mid-size tire plant produces about six million tires per year. However, in 2000, the Italian company Pirelli introduced a new tire factory that uses many robots. The Pirelli tire plant produced only about one million tires per year, but did so at a lower average cost than a traditional mid-sized tire plant.

Controversy has simmered in recent years over whether the new information and communications technologies will lead to a larger or smaller size for firms. On one side, the new technology may make it easier for small firms to reach out beyond their local geographic area and find customers across a state, or the nation, or even across international boundaries. This factor might seem to predict a future with a larger number of small competitors. On the other side, perhaps the new information and communications technology will create “winner-take-all” markets where one large company will tend to command a large share of total sales, as Microsoft has done in the production of software for personal computers or Amazon has done in online bookselling. Moreover, improved information and communication technologies might make it easier to manage many different plants and operations across the country or around the world, and thus encourage larger firms. This ongoing battle between the forces of smallness and largeness will be of great interest to economists, businesspeople, and policymakers.

Amazon

Traditionally, bookstores have operated in retail locations with inventories held either on the shelves or in the back of the store. These retail locations were very pricey in terms of rent. Amazon has no retail locations; it sells online and delivers by mail. Amazon offers almost any book in print, convenient purchasing, and prompt delivery by mail. Amazon holds its inventories in huge warehouses in low-rent locations around the world. The warehouses are highly computerized using robots and relatively low-skilled workers, making for low average costs per sale. Amazon demonstrates the significant advantages economies of scale can offer to a firm that exploits those economies.

Key concepts and summary

A production technology refers to a specific combination of labor, physical capital, and technology that makes up a particular method of production.

In the long run, firms can choose their production technology, and so all costs become variable costs. In making this choice, firms will try to substitute relatively inexpensive inputs for relatively expensive inputs where possible, so as to produce at the lowest possible long-run average cost.

Economies of scale refers to a situation where as the level of output increases, the average cost decreases. Constant returns to scale refers to a situation where average cost does not change as output increases. Diseconomies of scale refers to a situation where as output increases, average costs increase also.

The long-run average cost curve shows the lowest possible average cost of production, allowing all the inputs to production to vary so that the firm is choosing its production technology. A downward-sloping LRAC shows economies of scale; a flat LRAC shows constant returns to scale; an upward-sloping LRAC shows diseconomies of scale. If the long-run average cost curve has only one quantity produced that results in the lowest possible average cost, then all of the firms competing in an industry should be the same size. However, if the LRAC has a flat segment at the bottom, so that a range of different quantities can be produced at the lowest average cost, the firms competing in the industry will display a range of sizes. The market demand in conjunction with the long-run average cost curve determines how many firms will exist in a given industry.

If the quantity demanded in the market of a certain product is much greater than the quantity found at the bottom of the long-run average cost curve, where the cost of production is lowest, the market will have many firms competing. If the quantity demanded in the market is less than the quantity at the bottom of the LRAC, there will likely be only one firm.

Problems

A small company that shovels sidewalks and driveways has 100 homes signed up for its services this winter. It can use various combinations of capital and labor: lots of labor with hand shovels, less labor with snow blowers, and still less labor with a pickup truck that has a snowplow on front. To summarize, the method choices are:

Method 1: 50 units of labor, 10 units of capital

Method 2: 20 units of labor, 40 units of capital

Method 3: 10 units of labor, 70 units of capital

If hiring labor for the winter costs $100/unit and a unit of capital costs $400, what production method should be chosen? What method should be chosen if the cost of labor rises to $200/unit?

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Questions & Answers

why should a firm close down when it's unable to pay it's variable cost?
ANDREW Reply
what is oligopolistic competitive market?
ngong
exchange of goods and services between countries is call
Hosea Reply
what is constant opportunity cost
Tiffany Reply
Constant opportunity cost means the value of sacrifice remains constant in every step.
Dipam
Gross Domestic Product GDP
Yusuf Reply
what is g d p
Jayapal Reply
gross daily performance
domingo
How best can a poor country respond to an economic crisis , what does it have to sacrifice.
Bah Reply
they should pay tax as progressive system and should make sacrifice for taxation of their income and land etc
Hamza
how have the nations tries to solve the problem of scarcity in their economies?
Amani Reply
total concentration on to reduce the per unit cost of commodity by technically or whatever
Hamza
explain what will happen to producer of green coconut now that we have to lockdown in the kingdom of tonga
Tuha Reply
the demand for coconut will decrease and supply increases which result in the decrease in the price of coconut and the coconut will be more elastic
Hamza
tonga is producing more long run economic good explain the meaning of the statement and its implication on the tonga economy
Tuha Reply
Demand is the various quantities of goods and services that consumer(s)are willing and able to purchase at a price within a time
Muhammad Reply
What is demand
Mc Reply
demand relates with the need of people for their satisfaction.
Mohd
Distinguish between cross elasticity and income elasticity of demand
Ruth Reply
Distinguish between cross elasticity and income elasticity of demand
Ruth
if change in the demand of the commodity with respect to change in demand of the substitute or other product called cross elasticity
Hamza
and. if change in the demand of the commodity due to change in the income . called income elasticity
Hamza
👍
Vipul
Cross elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to a small change in price of another commodity whiles Income elasticity of demand is the degree of responsiveness of quantity demanded of a commodity to a small change in income of it's consumers
Afriyie
but these are book wordings
Hamza
income elasticity of demand shows how quantity demanded changes due to changes in income on the other hand cross elasticity refers to how the quantity demanded of a particular good alers given a change in the price of another good.
Keysie
what is the competitive demand
Adiza Reply
Income
Sanni
Competitive demand are those commodity dat are competitive in nature e.g the close up and my my toothpaste the increase in price of close up may bring abt decrease in demand of it and it will serve as increase in purchase of my my
Daniel
With regards to coal shortage and manicipal debts the what form of intervention do you think Eskom can put in place.
kedibone Reply
economic growth of Bhutan
Nima Reply
please, explain all the mathematics terms used in economics
nelson
The answer is: little more than high school algebra and graphs.
Tere

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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