Question

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, thereby reducing the total number to 2,500, what would you expect to happen to costs within the banking industry?

Please provide a detailed explanation in terms of what long-run average cost curve for the individual bank which is relatively flat means.What were the costs of the banks/banking industry previously and what will be the effects of costs on the overall banking industry.

The question carries 15 marks. Please provide a detailed answer to justice the question and marks.

Answer 1

Long run average cost for individual bank is flat which implies that there is no economies and diseconomies of scale. Traditionally, in return of scale when individual firm starts expanding its scale of operations, it initially experiences economies of scale and after optimum point, diseconomies of scale. But constant cost with increase in production means no benefit and loss in operation.

Consolidation of bank and reducing the No. Of banks from 5000 to 2500 which means now 2500 banks have responsibility and obligation to serve the customers by doubling it's output. The effect of this consolidation over total cost and average cost remained unchanged.

In the above figure,

Before consolidation lets suppose each bank producing quantity Q units of output

After Consolidation Each bank producing double units which is 2Q, Serving same no of customers.

Hence Average cost remained unchanged, therefore total cost remained unchanged.

Suppose if two banks producing units at average cost 10 and producing 100 units each bank. If that two banks being consolidated then 1 consolidated bank would produce 200 units of output and total cost would be 2000 which implies average cost remained at cost 10 per unit. Given long run average cost flat, average cost is 10 per unit and total cost of consolidated bank producing double units remained at 2000 as before. Therefore the effect over costs remained unchanged.