[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

144 ∂ CHAPTER 6 THE FIRM'S COSTS
adjust its fixed costs, the bumps in the long-run average cost curve will become
progressively smaller, enabling us to ignore them in most cases. Thus, when we
draw a long-run average cost curve, we will typically ignore the bumps and draw a
smooth curve.
But what does a smooth long-run average cost curve look like? Does it slope
upward or downward? Or is it flat? A good way to answer these questions is to ask
what happens to average costs if the firm doubles all its inputs. That is, it doubles
the number of workers it employs and the number of plants it operates. If output
also doubles when inputs are doubled, then average costs will remain unchanged.
More generally, if all inputs are increased in proportion and output then increases
by the same proportion, average costs will be constant. In this case, the long-run average
cost curve is flat, and we say there are constant returns to scale. Under these
conditions, changing the scale of production leaves average costs constant. Many
economists argue that constant returns to scale are most prevalent in manufacturing;
a firm can increase its production simply by replicating its plants. Similarly,
the average cost of teaching introductory economics to 500 students is the same as
it is for teaching it to 250 students. Just add another lecture hall and hire another
lecturer. When long-run average cost is constant, then the marginal cost of additional
output must be equal to the average cost (otherwise average costs would be changing);
thus the long-run average cost curve and the long-run marginal cost curve
are the same.
While constant returns to scale are common, other patterns are also possible.
Suppose all inputs are increased in proportion but output increases proportionately
less. For example, suppose all inputs are increased by 20 percent but output
rises by only 15 percent. Costs will have risen more than output, and average costs
therefore will have risen. This case is an example of diminishing returns to scale.
If there are diminishing returns to scale, the long-run average cost curve slopes
upward since long-run costs rise more than output as the firm expands production.
With diminishing returns to scale, small is beautiful and big is bad. As the
firm tries to grow, adding additional plants, management becomes more complex.
It may have to add layer upon layer of managers, and each of these layers increases
costs. When the firm is small, the owner can supervise all the workers. When the
firm grows, the owner can no longer supervise everyone and will have to hire a new
employee to help supervise. As the firm grows even larger, and more supervisors
are hired, eventually the owner needs someone to help supervise the supervisors.
Doubling the output of the firm may require not just doubling existing inputs but
adding new layers of bureaucracy that can slow decision making in the firm, adding
further to costs. Many small firms find they face these difficulties as they grow and
that their average costs increase. Firms that attempt to grow quickly often just as
quickly run into problems trying to contain costs, and many do not succeed. A
recent example of a company that faltered after expanding rapidly is the Krispy
Kreme Doughnut Corporation, which grew in the 1990s from a regional to a national
chain. Because long-run average costs rise with output when there are diminishing
returns to scale, the long-run marginal cost curve is above the long-run average
cost curve.