This document discusses long-run average costs. It explains that in the long-run, all costs are variable. It describes diminishing returns to increasing quantities of capital and labor. The long-run average total cost curve shows the lowest attainable average cost for different output levels when plant size and labor are varied. Economies of scale occur when a percentage increase in output exceeds a percentage increase in inputs, leading to falling long-run average costs. Diseconomies of scale arise from management complexity at large scales, causing long-run average costs to rise. Constant returns to scale yield a horizontal long-run average cost curve. Minimum efficient scale is the smallest output where long-run average cost is lowest.

1. LONG-RUN
AVERAGE COST
CHAPTER 22

2. LONG-RUN COSTS
• Remember: All costs in the long run
are variable!
• The behavior of long-run cost
depends on the firm’s production
function which is the relationship
between the maximum output
attainable and the quantities of both
labor and capital.

3. DIMINISHING RETURNS
Diminishing returns occur at
all the quantities of capital as
the quantity of labor
increases. The marginal
product of labor eventually
diminishes.

4. DIMINISHING PRODUCT
OF CAPITAL
The marginal product of
capital is the change in total
output divided by the change
in capital when the quantity
of labor is constant (the
change in output that results
from a one unit increase in
the quantity of capital)

5. TWO IMPORTANT THINGS:
1. Each short-run ATC curve is
U-shaped.
2. For each short run ATC
curve, the larger the plant,
the greater is the output at
which average total cost is a
minimum.

6. LONG-RUN AVERAGE
COST CURVE
The long-run average
total cost curve is the
relationship between the
lowest attainable average
total cost and output
when both the plant size
and labor are varied.

7. LONG-RUN AVERAGE
COST CURVE
• The long-run ATC curve is a
planning curve.
• It tells the firm the plant size and
the quantity of labor to use at
each output to minimize cost.
• Once the plant size is
chosen, the firm operates on the
short-run curves that apply to
that plant size.

8. LONG-RUN AVERAGE
COST CURVE
• The long-run ATC curve is a
planning curve.
• It tells the firm the plant size and
the quantity of labor to use at
each output to minimize cost.
• Once the plant size is
chosen, the firm operates on the
short-run curves that apply to
that plant size.

9. ECONOMIES OF SCALE
Economies of Scale result
from features of a firm’s
technology that lead to
falling long-run average cost
as output increases. The
main source of economies of
scales is greater
specialization of both labor
and capital.

10. ECONOMIES OF SCALE
With given input
prices, economies of scale
occur if the percentage
increase in output exceeds
the percentage increase in
all inputs.

11. DISECONOMIES OF SCALE
Diseconomies of Scale lead to
rising long-run average cost as
output increases. The main source
of diseconomies of scale is the
difficulty of managing a very large
enterprise. The larger the firm, the
greater the challenge of organizing it
and the communicating both up and
down the management levels and
among managers. Eventually,
management complexity brings rising
average cost.

12. CONSTANT RETURNS TO
SCALE
Constant returns to scale are
features of a firm’s technology that
lead to constant long-run average
cost as output increases.
When constant returns to scale are
present, LRAC curve is horizontal.

13. MINIMUM EFFICIENT
SCALE
Minimum efficient scale is the
smallest quantity of output at which
long-run average cost reaches its
lowest level.
A firm experiences economies of
scale up to some output level.
Beyond that level, it moves into
constant returns to scale or to
diseconomies of scale.
The MES plays a role in determining
market structure, as you will soon
learn in the next three chapters…

14. EXAMPLE
We’ll do exercise 10 from
your worksheet here in
class together, in your
notebook, and determine
both graphically and
algebraically, where Cathy
encounters economies of
scale!