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 1 440 280 240 320 480 800 2 620 380 240 240 380 620 3 800 480 320 240 280 440 Suppose Ike's Bikes is currently producing 600 bikes per month in its only factory. Its short-run average total cost isper 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 . 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 if it operates one factory ( ); use the purple points (diamond symbol) to plot its short-run average total cost if it operates two factories ( ); and use the orange points (square symbol) to plot its SRATC if it operates three factories ( ). Finally, plot the long-run average total cost (LRATC) 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.

Solution:

SHORT-RUN AVERAGE TOTAL COST:

Suppose Ike's bikes are currently manufacturing 200 bikes a month in its plant. In order to find the short run average total cost, since the quantity of bikes manufactured in the factory (Q)= 200 Search the average total cost in the table whose Q value is 200 (i.e. second column under average total cost) and the corresponding number of factories is 1 which is 280$.

Therefore, if Ike's bikes manufacture 200 bikes a month in its plant, the short-run estimated overall cost is $280.

LONG RUN AVERAGE TOTAL COST:

The average operating cost calculates how much of the overall cost of each unit of output is paid by the company. In the long term, a corporation would increase its income if it achieved the lowest potential overall total cost. Therefore, when deciding the size over the long term, the organization will pick the one at which the estimated net expense would be negligible.

In the long term, every company would prefer to pay the lowest potential overall operating costs. If Ike's Bikes aims to manufacture 200 bikes each month, we calculate the average cost under Q=200 (i.e. second column under average overall cost) from the above table to consider the smaller of the three values.

The smallest of the three numbers (or the lowest average long-term total cost) is $280 per wheel, which is the long-term average total cost.

In the long run, then, Ike's bikes will manufacture their 200 bikes in one factory (when Q=200, the amount of factories in the table corresponding to the estimated long-term overall production cost).

RANGE OF OUTPUT LEVELS IN WHICH IKE'S BIKES EXPERIENCE DIS-ECONOMIES OF SCALE IN LONG RUN:

Dis economies of scale is a condition in which the long-term average cost of production (LRAC) decreases with an change in per unit of products produced. Dis-economies of size exist when a product or industry expands to such an degree that costs per unit rise. Provided the first link, the rough graph demonstrates economies of production and economies of scale.

On the second attachment, graph, plot the three SRATC (Short Run Average Total Cost) curves for Ike's Bikes from the table in question. Specifically, I used the triangle symbol to plot its SRATC if it operates a single factory; used the dotted lines (diamond mark) to plot its STRATC if it operates two factories; used the square mark to plot its STRATC if it operates three factories. Finally, map the long run average total cost (LRATC) of Ike's bikes using the circle icon.

From the graph, we can see that, in the long run, Ike's bikes achieve economies of scale when the amount of bikes created is more than 400 every month.

We may also note that economies of scale are encountered where the quantity of bikes generated each month is less than 300. And a steady return to scale is felt when the amount of bikes produced is between 300 and 400 every month.

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