Cost Curves and Production Functions
Assuming that factor prices are constant, the production function determines all cost functions. The variable cost curve is the inverted short-run production function or total product curve and its behavior and properties are determined by the production function. Because the production function determines the variable cost function it necessarily determines the shape and properties of marginal cost curve and the average cost curves.
If the firm is a perfect competitor in all input markets, and thus the per-unit prices of all its inputs are unaffected by how much of the inputs the firm purchases, then it can be shown that at a particular level of output, the firm has economies of scale (i.e., is operating in a downward sloping region of the long-run average cost curve) if and only if it has increasing returns to scale. Likewise, it has diseconomies of scale (is operating in an upward sloping region of the long-run average cost curve) if and only if it has decreasing returns to scale, and has neither economies nor diseconomies of scale if it has constant returns to scale. In this case, with perfect competition in the output market the long-run market equilibrium will involve all firms operating at the minimum point of their long-run average cost curves (i.e., at the borderline between economies and diseconomies of scale).
If, however, the firm is not a perfect competitor in the input markets, then the above conclusions are modified. For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's per-unit cost, then the firm could have diseconomies of scale in that range of output levels. Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range.
Read more about this topic: Cost Curve
Famous quotes containing the words cost, curves, production and/or functions:
“One must always be aware, to notice—even though the cost of noticing is to become responsible.”
—Thylias Moss, African American poet. As quoted in the Wall Street Journal (May 12, 1994)
“At the end of every diet, the path curves back toward the trough.”
—Mason Cooley (b. 1927)
“Constant revolutionizing of production ... distinguish the bourgeois epoch from all earlier ones. All fixed, fast-frozen relations, with their train of ancient and venerable prejudices are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into air, all that is holy is profaned, and man is at last compelled to face with sober senses, his real conditions of life, and his relations with his kind.”
—Karl Marx (1818–1883)
“The mind is a finer body, and resumes its functions of feeding, digesting, absorbing, excluding, and generating, in a new and ethereal element. Here, in the brain, is all the process of alimentation repeated, in the acquiring, comparing, digesting, and assimilating of experience. Here again is the mystery of generation repeated.”
—Ralph Waldo Emerson (1803–1882)