Notes on Long Run Average Total Cost and Business Strategy

Long Run Average Total Cost Curve

• The long run average total cost (LRATC) curve is divided into three distinct areas:

  • Economies of Scale (Left Area)

  • As the output increases, the average cost decreases.

  • Efficiency is gained due to increased production capabilities.

  • Example: A factory generating more products at a lower per-unit cost due to larger scale production.

  • Constant Returns to Scale (Middle Area)

  • When production increases, the average cost remains constant.

  • Indicates maximum efficiency in production processes where size does not impact the cost.

  • Example: A factory operating at optimal capacity, regardless of size, maintaining the same cost per unit.

  • Diseconomies of Scale (Right Area)

  • Further increases in output lead to increased average costs.

  • This can occur when a company grows too large, leading to inefficiencies.

  • Example: Management and communication problems arise, increasing operational costs.

Historical Context of Ford and GM

• Ford's Initial Success

  • Dominated the automobile industry in the 1920s and 1930s.

  • Focused on mass production efficiency but became complacent after success.

  • Shifted focus during WWII to produce tanks and military vehicles, losing car production momentum.

• GM's Rise to Dominance

  • By the 1950s, GM surpassed Ford as the largest car manufacturer.

  • GM's success stemmed from better understanding of production efficiency and technology.

  • While Ford lagged due to overconfidence and poor adaptation post-war, GM capitalized on the economic boom.

Understanding Cost for Businesses

• Knowledge of cost structures is crucial for business sustainability and growth.

• The LRATC curve serves as a fundamental guide in making critical decisions regarding production strategies.

Problem-Solving Exercise

• Filling in the missing information in a cost structure is a key exercise to understand the concepts.

• Example given mentioned:

  • When quantity (q) equals zero, the variable cost is 0, leading to filling in a cost structure with values such as 10 + 30 = 40.

• Critical thinking and analysis will be required to solve cost-related problems in practical scenarios.