Overview
This lecture covers long run costs in economics, focusing on the concepts of economies of scale, constant returns to scale, and diseconomies of scale, and how these shape the long run average cost curve.
Short Run vs. Long Run Costs
- In the short run, some costs (like rent) are fixed, but in the long run, all costs become variable.
- In the long run, firms can adjust the scale of their operations, such as moving to a larger or smaller building.
- Each possible scale of operation has its own short run average total cost (ATC) curve.
Long Run Average Total Cost (LRATC) Curve
- The LRATC curve is formed by the lowest points (the "lower envelope") of all possible short run ATC curves.
- The LRATC shows the minimum cost of producing any output level when all inputs can be varied.
- Firms choose the scale of operation (which short run ATC) that minimizes costs at each level of output.
Economies, Constant Returns, and Diseconomies of Scale
- Economies of scale: As firms increase production, average total cost falls due to increased efficiency.
- Constant returns to scale: After a certain size, increasing output does not change average total cost.
- Diseconomies of scale: If a firm becomes too large, average total cost rises due to factors like management inefficiency.
Graphical Representation
- The LRATC curve slopes downward during economies of scale, flattens during constant returns, and slopes upward during diseconomies of scale.
- Only the lowest cost portions of each possible short run ATC curve determine the LRATC.
Key Terms & Definitions
- Long run — A period when all costs are variable and firms can change the scale of operations.
- Short run average total cost (ATC) curve — The cost per unit when at least one input is fixed.
- Long run average total cost (LRATC) curve — The minimum possible cost per unit at each output when all inputs are variable.
- Economies of scale — Decreasing average costs as production increases.
- Constant returns to scale — Output increases without changing average costs.
- Diseconomies of scale — Increasing average costs as production increases.
Action Items / Next Steps
- Review the shapes and implications of the LRATC curve.
- Prepare for Chapter 8: how firms maximize profits in perfect competition.