There are over 5,000 banks in the United States—more than 10 times more per person than...

There are over 5,000 banks in the United States—more than 10 times more per person than in other industrialized countries. A recent study suggests that the long-run average cost curve for an individual bank is relatively flat. If Congress took steps to consolidate banks (merge some of the banks), thereby reducing the total number to 2,500, what would you expect to happen to average costs within the banking industry?

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Expert Solution

In the long run, there are no fixed factor of production and hence no fixed cost. The firm can change its size or scale of plant and employ more or less inputs. Thus, in the long run all factors are variable and hence all costs are variable.
The long run average total cost (LAC) curve of the firm shows the minimum average cost of producing various level of output from all possible short run average cost curve(SAC). Thus the LAC curve is derived from the SAC curves. The LAC curve can be viewed as a series of alternative short run situations into any one of which the firm can move. Each SAC curve represents a plant of a particular size which is suitable for a particular range of output. The firm will,therefore, make use of the various plants up to that level where short run average costs falls with increase in output. It will not produce beyond the minimum short run average cost of producing various outputs from all the plants used together.

The Consolidation of 5000 banks to 2500 banks would mean that each one of the 2500 banks would have to double their production so as to serve the customers which was earlier served by 5000 banks. By doubling the Production, total cost and average cost would not rise or remain unchanged.
If before merger, each bank produced Q units of output (such that it's average cost is minimum) , now after consolidation it has to produce two time more.Such that average cost is minimum and remain unchanged

Suppose there are three banks each 200 units and AC is $10 .

Total output of 3 banks = 600 units

Total cost of 3 banks is = 600 x 10= 6000

Now if the three banks merge ,

In order to maintain the average cost $10, they have to produce 600 units sames at total cost of $6000.

Rahul Sunny answered 1 year ago

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