Attempts2.5 Keep the Highest: 2.5/4 6. Costs in the short run versus the long ru

Question

Attempts2.5 Keep the Highest: 2.5/4 6. Costs in the short run versus the long run Ike's Bikes is a major manufacturer of bicycles. Currently, the company produces bikes using only one factory. Howewer, it is considering expanding production to two or even three factories. The following table shows the company's short-run average cost esch month for various levels of production ift uses one, two. or three factories. (Note: Q equals the total quantity of bikes produced by all factores.) Average Cost (Dollars per bike) Number of Factories 100 200 300 70 115 400 500 600 80 30 20 160 115 70 20 20 20 30 Suppose Ike's Bikes is currently producing 500 bikes per month in its only factory. Its short-run average cost is Sper bike Suppose Ike's Bikes is expecting to produce 500 bikes per month for several years. In this case, in the long run, it would choose to produce bikes On the following graph, plot the three short-run average cost (SRAC) curves for Ike's Bikes from the previous tabie. Specificaly, use the green points (triangle symbol) to plot its short-run average cost if it operates one factory (SRACE use the purple points (diamand symbol) to plot its short-rum average cost if it operates two fectories (SRACand use the orange points (aquare symbor) to plot its short-run average cost ir it operates three factories (SRACs). Finally, plot the long-run average cost (L.RAC) for Ike's Bikes using the biue points (cirele symbo) Note: Plot your points in the order in which you would 1ike them connected. Line segments will connect the points automatically. QUANTITY OF OUTPUT (Bks) . @?

Explanation / Answer

1. When Ike's bike is producing 500 bikes per month in its only factory. Its short-run AC is calculated as: Total Cost/ Total Output

This is = 80/500 = 0.16

2. If Ike's bike is producing 500 bikes per month for several years, then the AC of production using different factories is calculated as follows:

Here, we see that the cost of production is lowest when 3 factories are producing, so in the long run, 3 factories are used to produce 500 bikes.

3. Decreasing returns to scale (DRS) occur when higher output leads to higher average long-run costs. From the given table we see that costs start rising after the output level of 400 bikes. So, for more than 400 bikes per month, we have DRS.

Number of factories TC AC(TC/500) 1 80 80/500=0.16 2 55 55/500=0.11 3 30 30/500=0.06

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