Question

There are over 5,000 banks in the United States—more than 10 times more per person than in other industrialized countries. A recent study suggests that the long-run average cost curve for an individual bank is relatively flat. If Congress took steps to consolidate banks (merge some of the banks), thereby reducing the total number to 2,500, what would you expect to happen to average costs within the banking industry? Please explain.

Answer 1

Answer: The flat long-run average cost curve depicts that in the banking services there are neither economies nor diseconomies of scale. Consolidation indicates that 2,500 banks would each have to double their output for providing the service to the consumers served initially by the 5,000 banks. However the total costs for the industry and corresponding average cost per firm remains the constant.

In the enclosed graph, before consolidation, assuming that each bank was producing Q units was serving Q number of customers. However each bank after consolidation now produces double times more; and it means moving from plant size 1 to plant size 2. The average cost and total costs won’t change.