Long run costs and scale

Define the long run

When all factors of production are variable

Define returns to scale

• The change in output when factors of production (i.e. inputs) increase

• Identifies the %∆ in output as a result of %∆ in input

Define increasing returns to scale

• When %∆ output > %∆ input

• Furthermore, the firm is producing at a greater rate than they are inputting, suggesting they have relatively high productivity

Define constant returns to scale

• When %∆ output = %∆ input

• Furthermore, the firm is producing at the same rate as they are inputting, suggesting they have unchanged productivity

Define decreasing returns to scale

• When %∆ output < %∆ input

• Furthermore, the firm is producing at a smaller rate than they are inputting, suggesting they have relatively low productivity

Describe the long run average cost curve

• U-shaped curve

• Initially decreases due to increasing returns to scale/economies of scale

• Secondly remains the same due to constant returns to scale

• Eventually increases due to decreasing returns to scale/diseconomies of scale

Define the minimum efficient scale (MES)

• The lowest level of output to fully exploit economies of scale

• The TQ where the LRAC immediately reaches constant returns to scale

Define a natural monopoly

• A market structure that has relatively high TFC, suggesting TQ must be relatively high before the firm can fully exploit economies of scale by minimising LRAC

• Furthermore, the LRAC curve will be L-shaped due to the MES being at a relatively high TQ before diseconomies of scale set in