Returns to Scale and Scope 247At this new exchange rate, Japan’s labor costs per unit of output (converted
into dollars) become 500/125 $4 and 1,250/125 $10 for the respective
goods. With the appreciation of the dollar, Japanese goods become less costly
(after converting into dollars). The U.S. cost advantage in pharmaceuticals has
narrowed significantly ($3.75 versus $4.00), whereas the Japanese cost advan-
tage in watches has widened. Accordingly, U.S. pharmaceutical exports should
decline; these exports simply are not as attractive to Japanese consumers as
before. In turn, a more expensive dollar (a cheaper yen) makes Japanese watch
exports more attractive to U.S. consumers.
To sum up, relative productivities, relative wages, and the prevailing
exchange rate combine to determine the pattern of cost advantage and trade.
With respect to the exchange rate, depreciation of a country’s currency
increases its exports and decreases its imports. A currency appreciation has
exactly the opposite effect.RETURNS TO SCALE AND SCOPE
Returns to Scale
Returns to scale are important because they directly determine the shape of
long-run average cost. They also are crucial for answering such questions as
Are large firms more efficient producers than small firms? Would a 50 percent
increase in size reduce average cost per unit? Although the exact nature of
returns to scale varies widely across industries, a representative description is
useful. Figure 6.4 depicts a long-run average cost curve that is U-shaped. This
reflects increasing returns to scale (and falling LAC) for low output levels and
decreasing returns (increasing LAC) for high levels. In the figure, the mini-
mum level of long-run average cost is achieved at output level Qmin. As in
Figure 6.3, SAC curves for three plants are shown. Thus, output Qminis pro-
duced using the medium-sized plant. If the costs of allpossible plants were
depicted, the lower “envelope” of the many SAC curves would trace out the
figure’s LAC curve. To sum up, if the firm is free to use anysize plant, its aver-
age production cost is exactly LAC.
As noted in Chapter 5, a number of factors influence returns to scale and,
therefore, the shape of long-run average cost. First, constant average cost(due to
constant returns to scale) occurs when a firm’s production process can be repli-
cated easily. For instance, the electronics repair firm may find it can double its
rate of finished repair jobs simply by replicating its current plant and labor
force—that is, by building an identical repair facility beside the existing one
and proportionally increasing its labor force. By duplication, the firm could
supply twice the level of service at an unchanged average cost per job.
Second, declining average coststems from a number of factors, including
capital-intensive mass production techniques, automation, labor specialization,c06CostAnalysis.qxd 9/29/11 1:46 PM Page 247