Question

5. Costs in the short run versus in the long run

Ike’s Bikes is a major manufacturer of bicycles. Currently, the company produces bikes using only one factory. However, it is considering expanding production to two or even three factories. The following table shows the company’s short-run average total cost (SRATC) each month for various levels of production if it uses one, two, or three factories. (Note: Q equals the total quantity of bikes produced by all factories.)

Number of Factories

Average Total Cost

(Dollars per bike)

Q = 100

Q = 200

Q = 300

Q = 400

Q = 500

Q = 600

1 360 200 160 240 400 720

2 540 300 160 160 300 540

3 720 400 240 160 200 360

Suppose Ike’s Bikes is currently producing 600 bikes per month in its only factory. Its short-run average total cost isper bike.

Suppose Ike’s Bikes is expecting to produce 600 bikes per month for several years. In this case, in the long run, it would choose to produce bikes using .

On the following graph, plot the three SRATC curves for Ike’s Bikes from the previous table. Specifically, use the green points (triangle symbol) to plot its SRATC curve if it operates one factory ( SRATC1

SRATC

1

); use the purple points (diamond symbol) to plot its SRATC curve if it operates two factories ( SRATC2

SRATC

2

); and use the orange points (square symbol) to plot its SRATC curve if it operates three factories ( SRATC3

SRATC

3

). Finally, plot the long-run average total cost (LRATC) curve for Ike’s Bikes using the blue points (circle symbol).

Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically.

SRATC

1

SRATC

2

SRATC

3

LRATC

0

100

200

300

400

500

600

700

800

720

640

560

480

400

320

240

160

80

0

AVERAGE TOTAL COST (Dollars per bike)

QUANTITY (Bikes)

In the following table, indicate whether the long-run average cost curve exhibits economies of scale, constant returns to scale, or diseconomies of scale for each range of bike production.

Range

Economies of Scale

Constant Returns to Scale

Diseconomies of Scale

Fewer than 300 bikes per month

Between 300 and 400 bikes per month

More than 400 bikes per month

Answer 1