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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