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Economies of scale

A) In the long-run in perfectly competitive industries the (long-run) supply curve of the industry can be derived. Explain likely outcomes (slopes) of long-run supply curve in various situations

B) Explain economies of scale. What are the major reasons for this phenomenon? What are the likely slopes (shapes) of the long-run average total cost curves?

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a)In the long run, entry by firms will produce a situation where the typical firm is earning normal profits only, even when they try to maximize profits. So not only does the MR = MC condition apply (profits are maximized), but also the statement P = ATC applies as well (the price per unit covers all costs per unit including a normal profit, but no more).

Suppose an increase in demand (from D1 to D2) occurs, raising the price which the typical firms receives, as set by the broad market. The firm will, in the short run, adjust production from Q1 to Q2, where it is again maximizing its profits-and is now making economic (above-normal) profits!

But these profits attract entry, again. So market supply starts increasing as new firms enter, and the price line starts coming down, eventually eliminating economic profits, as before. Only this time, we have to recognize that as new firms are formed, they will increase demand for the scarce resources which are needed by the new firms. So in the resource markets, increasing demand for engineers, raw materials, skilled labor of various kinds, and many other resources, may increase the prices of these resources. Since our formula for average cost of production is PL/APL, an increase in the ...

Solution Summary

The response does an excellent job of addressing the student's question. The solution begins by explaining the likely outcomes of long run supply curve in various situations and then explains the several economies of scale. The solution is detailed and very well written. It is also very easy to understand by any student who wants to learn more about the supply curve and economies of scale. Overall, an excellent response.