Production and Cost Theory

I've learned a great deal about production and cost decisions, but most of the principles I have already been exposed to.  For instance, the relationships between marginal and average cost and marginal and average product have been a part of most of my economics classes, as well as the dictum to ignore fixed costs for short-term decisions.  In general, while I did learn some things and the review was useful, Chapter 8 on the short-run was old hat for me.

Chapter 9, the long-run, was newer to me.  I had seen isoquants before but had not had the benefit of the in-depth treatment in this chapter.  More illuminating is the description of expansion paths between short- and long-term, and the strategic considerations that such an analysis allows.  The many elegant graphs throughout these chapters (and the text) aid my understanding.

Finally, the discussion of economies of scale and scope were a helpful review, and the "economy of experience" I had not come across before.  To be sure, I need to review both of these chapters to help me understand everything better.

The difference between the short- and long-runs is simple: in the short-run, only variable costs have a bearing on decision making, while in the long-run every cost is "variable".  The long-run is the planning horizon: "...the collection of all possible short-run situations."  In the long-run everything is possible: move production overseas, buy new capital, enter a new market, close down business.  In the short-run, we can make decisions only with those resources that are immediately disposable and have a direct bearing on production, such as hiring/firing workers; that is, the short-run variable costs.

Many companies take advantage of economies of scale and scope.  In fact, we might say that all companies take advantage of these concepts, because they are the long-run applications of short-term decision making theory (deciding on the margin).  Where I work, for instance, we try to take advantage of an economy of scope when we both deliver/pick-up the furniture as well as selling it, since we can provide the service of delivery for less in-house than it would cost to outsource it to another company.

The LRAC diminishes over time as output increases for industries with a high up-front investment, such as water treatment, steel refinement, or oil production.  That is, it takes an enormous amount of resources to create an infrastructure capable of doing steel refinement, and that massive up-front cost is averaged over each ingot produced.

Similarly, new drugs can really only be developed by companies with massive resources because of the huge expense of research, testing, and the high risk associated with the industry.

An economy of scale is also present in shipping: if you can ship more items / freight carrier, average cost per item goes down.

Supermarkets often band together in trade associations and other loose forms of cooperation in order to buy in bulk, lowering the average cost for all firms.