Long Run Production Costs

Define Long Run Average Cost (LRAC) curve

LRAC shows the lowest possible AC of producing at any given level of output; shaped by the internal economies and diseconomies of scale.

Any point on the LRAC curve is said to be productively efficient.

Define Economies Of Scale

Cost savings that the firm enjoys when it increases its scale of production or when the whole industry expands, leading to a decrease in the cost per unit of production.

How are economies of scale generated?

• Internally

• Externally

Define diseconomies of scale

Cost dis-savings a firm faces when it increases its scale of production or when the entire industry expands, leading to an increase in the cost per unit of production.

Define internal economies of scale 

Cost savings that a firm enjoys when it increases its scale of production within the firm, leading to a decrease in the LRAC per unit of production.

How are internal EOS represented on a diagram?

Downward movement along the LRAC curve

(y-axis: costs; x-axis: output)

Define internal diseconomies of scale

Cost dis-savings incurred by a firm when expanding scale of production, leading to an increase in the LRAC per unit of production.

How are internal dis-EOS represented on a diagram?

Downward movement along the LRAC curve

Define external EOS

Cost savings earned by a firm when the industry expands, leading to an decrease in the LRAC per unit of production

Define external dis-EOS

Costs dis-savings incurred by a firm when the industry expands, leading to an increase in the LRAC per unit of production

What does the significance (in magnitude) of reaping large internal EOS mean? 

The firm is likely to be large and the industry is likely dominated by a few large firms (oligopoly) 

What does the significance (in magnitude) of reaping limited internal EOS mean? 

The firm is likely to be small and the industry comprises of many small firms; with small market shares

Purpose of external (dis)-EOS 

Considered when deciding where production should take place — factors of ext. EOS: price of labour and congestion of traffic/pollution. 

(the cost-savings from internal EOS may not be able to outweigh the cost dis-savings arising from external EOS) 

Define minimum efficient scale (MES) 

The lowest output at which the firm can produce at so that LRAC is minimized

How is MES represented on a diagram?

It is represented by the lowest point on the LRAC curve

Purpose of MES

Indicates:

• Size of the firm

• No. of firms in the industry

If MES is large relative to market demand, then the market consists of small no. of large firms.

If MES is small relative to market demand, then market consists of large no. of small firms.