Long-Run Production Costs

Long-Run ATC curve

long-run average total cost (LRATC) curve

• shows the lowest average total cost possible when a firm can change all inputs

• shaped by connecting the lowest points of all short-run ATC curves

• it's called an envelope curve because it wraps around the bottom of the SRATC curves

relationship to short-run ATC

• each SRATC is based on a fixed plant size or resource

• the LRATC assumes flexibility in changing all resources (no fixed inputs)

• firms can switch between SRATC curves to stay on the LRATC as they grow

Economies and Diseconomies of Scale

Economies of Scale

• Definition: LRATC declines as output increases

• Causes:

  • Specialization of labor and management

  • Bulk purchasing of inputs

  • Efficient use of capital and technology

• Graphical Representation: Downward-sloping portion of the LRATC curve

Diseconomies of Scale

• Definition: LRATC increaess as output increases

• Causes:

  • Coordination and communication difficulties

  • Bureaucratic inefficiencies

  • Resource limitations leading to higher input costs

• Graphical Representation: Upward-sloping portion of the LRATC curve

Constant Returns to Scale

• Definition: When increasing production does not change LRATC

• Graphical Representation: Flat portion of the LRATC curve

Minimum Efficient Scale and Market Concentration

• Definition: The smallest quantity of output at which a firm achieves the lowest long-run average total cost (LRATC).

• Significance: Firms operating at or above MES can produce efficiently; those below may struggle to compete due to higher per-unit costs

MES and Market Structure

• MES vs. Market Size:

  • If MES is a small fraction of total market demand, many firms can operate efficiently, leading to a competitive market

  • If MES is large relative to market demand, only a few firms can achieve efficiency, resulting in a concentrated market or natural monopoly

• Natural Monopoly:

  • Occurs when a single firm can supply the entire market at a lower cost than multiple firms due to economies of scale