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 = 50	Q = 100	Q = 150	Q = 200	Q = 250	Q = 300
1	220	140	120	160	240	400
2	310	190	120	120	190	310
3	400	240	160	120	140	220

Suppose Ike’s Bikes is currently producing 300 bikes per month in its only factory. Its short-run average total cost isper bike.

Suppose Ike’s Bikes is expecting to produce 300 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.

SRATC1SRATC2SRATC3LRATC05010015020025030035040036032028024020016012080400AVERAGE TOTAL COST (Dollars per bike)QUANTITY OF OUTPUT (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 200 bikes per month
Fewer than 150 bikes per month
Between 150 and 200 bikes per month

Answer 1

Suppose Ike’s Bikes is currently producing 300 bikes per month in its only factory. Its short-run average total cost is 400 per bike.

Suppose Ike’s Bikes is expecting to produce 300 bikes per month for several years. In this case, in the long run, it would choose to produce bikes using three factories as the long run cost is lowest there.

No. Of Factories	50	100	150	200	250	300
SRATC 1	220	140	120	160	240	400
SRATC 2	310	190	120	120	190	310
SRATC 3	400	240	160	120	140	220

Plot the graph as follows:

Connect all the lowest points,this would represent the LRATC curve of the firm

Range	Economies of Scale	Constant Returns to Scale	Diseconomies of Scale
More than 200 bikes per month			Yes
Fewer than 150 bikes per month	Yes
Between 150 and 200 bikes per month		Yes