Long-Run Costs*Long-Run Costs*

IB-HL Economics

Mr. Messere – BBB 4M7Victoria Park C.I.

*This is for all the lazy IB-HL students who are late &/or too exasperated to take notes in class. I should get paid extra $$$ for this eh? Enjoy!

Long-Run Average CostLong-Run Average Cost

• Long-run average cost refers to the minimum short-run average cost at each possible level of output

• The firm will choose the plant size that minimizes cost for any desired output level– The firm’s LRAC is tangent to the infinite

number of short-run average cost curves – for this reason the LRAC curve is sometimes called the envelope curve

Long-Run Average CostLong-Run Average Cost

LRAC and Returns to ScaleLRAC and Returns to Scale Three possible results:• Increasing returns to scale (Range A)• Constant returns to scale (Range B)• Decreasing Returns to scale (Range C)

LRAC and Returns to ScaleLRAC and Returns to Scale

– Increasing Returns to Scale / Economies of Scale (falls in the initial output Range A between AC1 and AC2) – situation in which a percentage increase in all inputs causes a larger percentage increase in output (eg. assembly-line manufacturing); caused by:• Specialization of labour

• Specialized capital

• Specialized management

LRAC and Returns to ScaleLRAC and Returns to Scale

– Constant Returns to Scale (occurs in Range B between AC2 and AC3)– situation in which a percentage increase in all inputs results in an equal percentage increase in output (eg. craft industries, manufacturing)

– Decreasing Returns to Scale (occurs in range C beyond AC3) – situation in which a percentage increase in all inputs leads to a smaller percentage decrease in output (eg. primary industries); caused by:• management difficulties• limited natural resources

Minimum Efficient Scale (MES)Minimum Efficient Scale (MES)

– (MES) is the output for a business in the long run where the internal economies of scale have been fully exploited.

– It corresponds to the lowest point on the long run average total cost curve (aka ‘output of long run productive efficiency’)

– MES is rarely a single output - more likely it is a range of output levels where average cost is minimized where the firm achieves constant returns to scale.

– MES varies from industry to industry depending on the nature of the cost structure in a particular sector of the economy.

Minimum Efficient Scale (MES)Minimum Efficient Scale (MES)

(MES) is useful in determining the likely market structure of a market.

i.e. if minimum efficient scale small relative to the overall size of the market (demand for the good), there will be a large number of firms as in perfect competition

Practice