Encyclonomic WEB*pedia: LONG-RUN AVERAGE COST

LONG-RUN AVERAGE COST:
The per unit cost of producing a good or service in the long run when all inputs under the control of the firm are variable. In other words, long-run total cost divided by the quantity of output produced. Long-run average cost is guided by returns to scale.
Long-run average cost is the per unit cost incurred by a firm in production when all inputs are variable. In particular, it is the per unit cost that results as a firm increases in the scale of operations by not only adding more workers to a given factory but also by building a larger factory.
Not the Short Run
In the long run, when all inputs under the control of the firm are variable, there is no fixed cost and thus no average fixed cost. As such, there is no need to distinguish between average total cost and average variable cost. In the long run, average cost is merely average cost.
With no fixed inputs in the long run, increasing and decreasing marginal returns, and especially the law of diminishing marginal returns, are not relevant to long-run average cost. There are, however, two similar influences, economies of scale (or increasing returns to scale) and diseconomies of scale (or decreasing returns to scale).
The Short Run: In the short run, average total cost decreases due to increasing marginal returns and increases due to decreasing marginal returns and the law of diminishing marginal returns. This triggers changes in marginal cost and thus average cost (variable and total).

The Long Run: In the long run, there are no fixed inputs. As such, marginal returns and especially the law of diminishing marginal returns do not operate and do not guide production and cost. Instead long-run average cost is affected by increasing and decreasing returns to scale, which translates into economies of scale and diseconomies of scale.
Scale Economies
Long-run average cost is guided by scale economies and returns to scale.
Economies of Scale: For relatively small levels of production, a firm tends to experience economies of scale and increasing returns to scale. These result because an increase in the scale of operations (a proportional increase in all inputs under the control of the firm) causes a decrease in average cost.

Diseconomies of Scale: For relatively large levels of production, a firm tends to experience diseconomies of scale and decreasing returns to scale. These result because an increase in the scale of operations causes an increase in average cost.
A U-shaped Curve
Long-Run Average Cost Curve
Scale economies and returns to scale generally produce a U-shaped long-run average cost curve, such as the one displayed to the right. For relatively small quantities of output, the curve is negatively sloped. Then for large quantities, the curve is positively sloped.
While the shape of the long-run average cost curve looks surprisingly like that of a short-run average cost curve, the underlying forces are different. This U-shape is NOT the result of increasing, then decreasing marginal returns that surface in the short run when a variable input is added to a fixed input.
The negatively-sloped portion of this long-run average cost curve reflects economies of scale and increasing returns to scale. The positively-sloped portion reflects diseconomies of scale or decreasing returns to scale.
Minimum Efficient Scale
The long-run average cost curve is extremely important to the long-run production efficiency of a firm. The main point of interest is the minimum of the long-run average cost curve, achieved at 300 in the exhibit. The quantity of output that achieves this minimum is termed the minimum efficient scale (MES). This level of production achieves the lowest possible average cost in the long run.
It is not possible to produce this good in such a way that reduces the opportunity cost of foregone production, of giving up any less value from other production, than is achieved at the MES.
Two More Curves
Long-run cost is reflected by three curves. In addition to the long-run average cost curve, there is the long-run total cost curve and the long-run marginal cost curve. Each has a similar interpretation in the long run as the short run.
Long-run Total Cost: This curve graphically illustrates the relation between long-run total cost, which is the total opportunity cost incurred by all of the factors of production used in the long run by a firm to produce a good or service, and the level of production.

Long-run Marginal Cost: This curve graphically illustrates the relation between long-run marginal cost, which is the change in the long-run total cost of producing a good or service resulting from a change in the quantity of output produced, and the level of production. It is also the slope of the long-run total cost curve.
Check Out These Related Terms...
     | long-run total cost | long-run marginal cost | economies of scale | diseconomies of scale | minimum efficient scale | planning horizon |
Or For A Little Background...
     | returns to scale | increasing returns to scale | decreasing returns to scale | long-run production analysis | long-run, microeconomics | average cost | opportunity cost | fixed input | variable input | marginal returns | marginal analysis | microeconomics |
And For Further Study...
     | long-run average cost curve, derivation | long-run, macroeconomics | average total cost curve | law of diminishing marginal returns | short-run production analysis | U-shaped cost curves | opportunity cost, production possibilities |
Recommended Citation:
     LONG-RUN AVERAGE COST, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2025. [Accessed: January 30, 2025].