LABOR-LEISURE TRADEOFF: The perpetual tradeoff faced by human beings between the amount of time spent engaged in wage-paying productive work and satisfaction-generating leisure activities. The key to this tradeoff is a comparison between the wage received from working and the amount of satisfaction generated from leisure. Such a comparison generally means that a higher wage entices people to spend more time working, which entails a positively sloped labor supply curve. However, the backward-bending labor supply curve results when a higher wage actually entices people to work less and to "consume" more leisure time.
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LONG-RUN MARGINAL COST:
The change in the long-run total cost of producing a good or service resulting from a change in the quantity of output produced. Like all marginals, long-run marginal cost is an increment of the corresponding total. It is the change in long-run total cost divided by, or resulting from, a change in quantity. Long-run marginal cost is guided by returns to scale rather than marginal returns. Long-run marginal cost is the incremental cost incurred by a firm in production when all inputs are variable. In particular, it is the extra cost that results as a firm increases in the scale of operations by not only adding more workers to a given factory but also by building a larger factory.
Not the Short RunIn the long run, when all inputs under the control of the firm are variable, there are no fixed inputs. With no fixed inputs, increasing and decreasing marginal returns, and especially the law of diminishing marginal returns, are not relevant to long-run marginal cost. There are, however, two similar influences, economies of scale (or increasing returns to scale) and diseconomies of scale (or decreasing returns to scale).
- The Short Run: In the short run, marginal cost decreases due to increasing marginal returns and increases due to decreasing marginal returns and the law of diminishing marginal returns. This also triggers changes in average cost (variable and total).
- The Long Run: In the long run, there are no fixed inputs. As such, marginal returns and especially the law of diminishing marginal returns do not operate and thus do not guide production and cost. Instead long-run marginal cost is affected by increasing and decreasing returns to scale, which translates into economies of scale and diseconomies of scale.
Scale EconomiesLong-run marginal cost is guided by scale economies and returns to scale.
- Economies of Scale: For relatively small levels of production, a firm tends to experience economies of scale and increasing returns to scale. These result because an increase in the scale of operations (a proportional increase in all inputs under the control of the firm) causes a decrease in marginal cost.
- Diseconomies of Scale: For relatively large levels of production, a firm tends to experience diseconomies of scale and decreasing returns to scale. These result because an increase in the scale of operations causes an increase in marginal cost.
A U-shaped Curve
Scale economies and returns to scale generally produce a U-shaped long-run marginal cost curve, such as the one displayed to the right. For relatively small quantities of output, the curve is negatively sloped. Then for large quantities the curve is positively sloped.
|Long-Run Marginal Cost Curve
While the shape of the long-run marginal cost curve looks surprisingly like that of a short-run marginal cost curve, the underlying forces are different. This U-shape is NOT the result of increasing, then decreasing marginal returns that surface in the short run when a variable input is added to a fixed input.
The negatively-sloped portion of this long-run marginal cost curve reflects economies of scale and increasing returns to scale. The positively-sloped portion reflects diseconomies of scale or decreasing returns to scale.
The long-run marginal cost curve is extremely important to the long-run profit maximization of a firm. In the same way that a firm maximizes economic profit in the short run by equating marginal revenue with (short-run) marginal cost, a firm maximizes economic profit in the long run by equating marginal revenue with long-run marginal cost. The key difference is that long-run marginal cost is not attributable to just one or two variable inputs, but to all inputs.
In other words, a profit-maximizing firm equates marginal revenue with the incremental cost of not just hiring more employees, but of building a larger factory, too.
An extremely important point of interest regarding long-run marginal cost is that it is equal to long-run average cost at the minimum of the long-run average cost curve. This quantity of output that achieves the minimum efficient scale (MES).
Two More CurvesLong-run cost is reflected by three curves. In addition to the long-run marginal cost curve, there is the long-run total cost curve and the long-run average cost curve. Each has a similar interpretation in the long run as the short run.
- Long-run Total Cost: This curve graphically illustrates the relation between long-run total cost, which is the total opportunity cost incurred by all of the factors of production used in the long run by a firm to produce a good or service, and the level of production. Long-run marginal cost is the slope of the long-run total cost curve.
- Long-run Average Cost: This curve graphically illustrates the relation between long-run average cost, which is the per unit cost incurred by all of the factors of production used in the long run by a firm to produce a good or service, and the level of production.
LONG-RUN MARGINAL COST, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 5, 2024].
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