Overview
This lecture explains the concept of long run costs of production, focusing on economies and diseconomies of scale and their causes, as well as distinctions between returns to scale.
Long Run Average Cost Curve
- The long run average cost (LRAC) curve is an envelope of infinite short run average cost curves.
- The LRAC shows cost per unit in the long run versus level of output.
- There is a range where LRAC falls (economies of scale), reaches a minimum, then rises (diseconomies of scale).
Economies of Scale
- Economies of scale occur when LRAC falls as a firm increases the scale of production.
- This is due to increased output and expanding all factors of production.
- Economies of scale lead to increasing returns to scale (output increases more than inputs).
- Sources: specialization, division of labor, bulk buying, financial, transport, technical, and promotional economies.
Diseconomies of Scale
- Diseconomies of scale occur when LRAC rises with increased scale of output.
- This results in decreasing returns to scale (output increases less than inputs).
- Causes include control and communication problems, alienation, and loss of worker identity.
Internal vs. External (Dis)Economies of Scale
- Internal economies/diseconomies result from growth in the firm's own size.
- External economies/diseconomies result from growth or concentration within the whole industry.
- External economies often arise when similar firms cluster, leading to shared resources and skilled labor.
- External diseconomies occur when too many firms compete for limited resources, raising costs.
Distinction: Economies vs. Returns to Scale
- Economies/diseconomies of scale focus on cost changes from scaling up.
- Returns to scale focus on output changes relative to input increases.
Key Terms & Definitions
- Long Run Average Cost (LRAC) — The cost per unit when a firm can vary all inputs, over a long period.
- Economies of Scale — Cost savings per unit from increasing production scale.
- Diseconomies of Scale — Rising cost per unit from increasing production beyond an efficient scale.
- Increasing Returns to Scale — Output increases more than the increase in inputs.
- Decreasing Returns to Scale — Output increases less than the increase in inputs.
- Internal Economies/Diseconomies — (Dis)savings from changes within a single firm.
- External Economies/Diseconomies — (Dis)savings arising from the industry's growth or concentration.
Action Items / Next Steps
- Review examples of internal and external economies and diseconomies.
- Prepare to explain the differences between economies of scale and returns to scale in class.