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CHAPTER CONTENTS
LEARNING OUTCOMES -------------------------------------------------- 69
TYPES OF COST ---------------------------------------------------------- 70
SHORT RUN COST BEHAVIOUR ----------------------------------------- 72
LONG RUN COST BEHAVIOUR ------------------------------------------ 74
IMPACT OF LONG RUN COSTS ON INDUSTRY STRUCTURE ---------- 77

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LEARNING OUTCOMES
(a)

s in the short run

and long run.

(b) Illustrate the potential effects of long run cost behavior on prices, the size of
the organization and the number of competitors in the industry.

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TYPES OF COST
1.

Fixed costs

2.

Variable costs

3.

Average cost

4.

Total cost

5.

Marginal cost

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Total cost curves (linear)

$
Total cost

Total variable cost

Total fixed cost

Quantity

Interpreting total cost curves

It is important to understand the relationship between the cost curves and the
impact resulting from cost variations.

Discussion 1
Complete the following sentences with regard to the impact on the total cost curve:

(a)
1.

2.

(b)
1. Illustrate the above diagrammatically.

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SHORT RUN COST BEHAVIOUR

for the purposes of cost analysis, is the period of time during which
the amount of at least one factor of production is fixed.
Straight line cost curves make the underlying assumption that the variable cost per
unit remains constant, thus ignoring altering levels of efficiency.

Curvilinear total cost curve

As a consequence of varying efficiency the total cost curve is more likely to adopt

Discussion 2
Indicate on the following diagram the points that correspond to: Increasing
efficiency, reducing efficiency, constant efficiency and the relevant range.
$

Total Cost

Quantity

Exercise 1
What is the effect on the total cost curve of a rise in fixed costs?
A

The total cost curve shifts up and becomes shallower

The total cost curve becomes steeper

The total cost curve shifts up but retains its original shape

The total cost curve shifts up and becomes steeper

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Short run average cost and marginal cost

It is important to understand the relationship between marginal cost and variable
cost.
$

Marginal cost
Average
total cost

Quantity

Discussion 3
Indicate on the following diagram the points that correspond to: optimal output,
increased efficiency/returns and diminishing returns/efficiency.

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LONG RUN COST BEHAVIOUR

In the long run a firm can alter its scale of production.
Long run average cost curve:

Key terms:
Economies of scale

output increases more than in proportion to inputs.

Constant returns to scale

Diseconomies of scale
Minimum efficient scale
economies of scale.

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output increases in proportion to inputs.

output increases less than proportionately to inputs.

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Economies of scale
There are two types of economy of scale, internal and external. Exam questions
are likely to focus upon differentiating between the two, as well as categorising the
main types of internal economy of scale!
Internal economies of scale
organises production.

arise as a result of the manner in which the firm

Complete the following table, providing examples of each Technical economies

Organisational economies

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Commercial economies

Financial economies

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External economies of scale

whole.

arise as a result of the growth of the industry as a

The main examples include:

A large skilled labour force
Specialised ancillary industries
Government assistance.
Diseconomies of scale
The source of diseconomies of scale typically derive
from managerial, human and behavioural problems.
As the size of a firm increases the following factors are likely to impair output:
Communication breakdowns
Increased decision making time
Morale / staff conflict
Loss of control on the part of senior management.

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IMPACT OF LONG RUN COSTS ON INDUSTRY STRUCTURE

The ability of a firm to minimise its long run average costs will enable it to reduce
competition by under cutting on price. It is not uncommon for established firms to
drive up fixed costs in order to force out rivals.
Michael Porter identified three generic strategies by which firms can compete
profitably. These include:
Cost leadership
Differentiation
Focus

provide product at the lowest cost.

provide a product of a higher benefit or value.

avoid going into competition with large firms.

Exercise 2
Categorise the following firms according to Porters generic strategies:
Ryanair
Waitrose
Airways - Rolex
Cost Leadership

Lidl

Ferrari - Dyson Vacuum Cleaners

Differentiation

Primark

Qatar

Focus

In order to achieve cost leadership, firms may wish to consider either outsourcing
activities or off-shoring an entire business unit.

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