Long run average cost. Returns to Scale.

Therefore, the long run average cost (LRAC) – the lowest average cost for each output range – is described by the "lower envelope curve," shown by the thick, shaded curve that follows the lowest of the three short run curves in each range.

More realistically, an investment planner will have to choose between many different plant sizes or firm scales of operation, and so the long run average cost curve will be smooth, something like this:

As shown, each point on the LRAC corresponds to a point on the SRAC for the plant size or scale of operation that gives the lowest average cost for that scale of operation.

Returns to ScaleThe cost per unit changes as the scale of operation or output size changes. Here is some terminology to describe the changes:

– average cost decreases as output increases in the long run = increasing returns to scale = decreasing cost

– average cost is unchanged as output varies in the long run = constant returns to scale = constant costs

– average cost increases as output increases in the long run =decreasing returns to scale = increasing costs

Here are pictures of the average cost curves for the three cases:

1. Increasing returns to scale = decreasing cost

It is necessary to use less productive methods to produce the smaller amounts. Thus, costs increase less than in proportion to output – and average costs decline as output increases.

Increasing Returns to Scale is also known as "economies of scale" and as "decreasing costs."

2. Constant returns to scale = constant costs

One machinist used one machine tool to do a series of operations to produce one item of a specific kind - and to double the output you had to double the number of machinists and machine tools.Constant Returns to Scale is also known as "constant costs.

3. Decreasing returns to scale = increasing costs

Decreasing returns to scale are associated with problems of management of large, multi-unit firms.

. Decreasing Returns to Scale is also known as "diseconomies of scale" and as "increasing costs".

Date: 2016-03-03; view: 820