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 is

per 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 one factory/two factories/three factories.

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 (SRATC1SRATC1); use the purple points (diamond symbol) to plot its SRATC curve if it operates two factories (SRATC2SRATC2); and use the orange points (square symbol) to plot its SRATC curve if it operates three factories (SRATC3SRATC3). 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.

SRATC1SRATC2SRATC3LRATC0100200300400500600700800720640560480400320240160800AVERAGE 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
More than 400 bikes per month
Between 300 and 400 bikes per month
Fewer than 300 bikes per month

Answer 1

Blanks-

1) 720

2) three factories

	Average total cost (Dollars per bike) at the various quantity (Q)
No. Of Factories	100	200	300	400	500	600
SRATC 1	360	200	160	240	400	720
SRATC 2	540	300	160	160	300	540
SRATC 3	720	400	240	160	200	360
LRATC	360	200	160	160	200	360

The LRATC curve would be the minimum points at each output level so the points will overlap

More than 400 bikes = diseconomies of scale

Between 300 and 400 = constant returns to scale

Fewer than 300 = Economies of scale