Basic Economics

Long Run Costs
Long run costs are accumulated when firms change production levels over time in response to
expected economic profits or losses. In the long run there are no fixed factors of production. The
land, labor, capital goods, and entrepreneurship all vary to reach the long run cost of producing a
good or service. The long run is a planning and implementation stage for producers. They
analyze the current and projected state of the market in order to make production decisions.
Efficient long run costs are sustained when the combination of outputs that a firm produces
results in the desired quantity of the goods at the lowest possible cost. Examples of long run
decisions that impact a firm’s costs include changing the quantity of production, decreasing or
expanding a company, and entering or leaving a market.
The long-run average-total-cost curve: unlimited number of plant sizes. If the number of
possible plant sizes is very large, the long-run average total- cost curve approximates a smooth
curve. Economies of scale, followed by diseconomies of scale, cause the curve to be U-shaped.
Economies of Scale and Diseconomies of Scale

Economies of scale, or economies of mass production, explain the down sloping part of the long-
run ATC curve, followed by diseconomies of scale cause the curve to be U-shaped. Economies
of scale is a long run concept and refers to reductions in unit cost as the size of a facility, or
scale, increases.
Diseconomies of scale are the opposite. Economies of scale may be utilized by any size firm
expanding its scale of operation. The common ones are purchasing (bulk buying of materials
through long-term contracts), managerial (increasing the specialization of managers), financial
(obtaining lower-interest charges when borrowing from banks and having access to a greater
range of financial instruments), and marketing (spreading the cost of advertising over a greater
range of output in media markets). Each of these factors reduces the long run average costs
(LRAC) of production by shifting the short-run average total cost (SRATC) curve down and to
the right.
In time the expansion of a firm may lead to diseconomies and therefore higher average total
costs. The main factor causing diseconomies of scale is the difficulty of efficiently controlling
and coordinating a firm’s operations as it becomes a large-scale producer. In a small plant a
single key executive may make all the basic decisions for the plant’s operation. Because of the
firm’s small size, the executive is close to the production line, understands the firm’s operations,
and can digest information and make efficient decisions.
Various possible long-run average-total-cost curves.
In (a), economies of scale are rather rapidly obtained as plant size rises, and diseconomies of
scale are not encountered until a considerably large scale of output has been achieved. Thus,
long-run average total cost is constant over a wide range of output.
In (b), economies of scale are extensive, and diseconomies of scale occur only at very large
outputs. Average total cost therefore declines over a broad range of output.
In (c), economies of scale are exhausted quickly, followed immediately by diseconomies of
scale. Minimum ATC thus occurs at a relatively low output.
Constant Returns to Scale

The concept of “returns to scale” describes the rate of increase in production relative to the
associated increase in the factors of production in the long run. In other words, it describes how
effectively and efficiently—in other words, profitably—a particular company or business is
producing its goods or services. At this point, all factors of production are variable (not fixed)
and can scale up. Therefore, the scale of production can be changed by changing the quantity of
all factors of production.
Conceptualizing “returns to scale” is an effort to specifically understand how production
increases relative to factors contributing to production. Production functions typically include
capital as well as labor.
Constant returns to scale occur when the output increases in exactly the same proportion as the
factors of production. In other words, when inputs (i.e., capital and labor) increase, outputs
likewise increase in the same proportion as a result. As an example of constant returns to scale, if
the factors of production are doubled, then the output will also be exactly doubled.

Basic Economics

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Basic Economics

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Long Run Costs

Economies of Scale and Diseconomies of Scale

Constant Returns to Scale

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