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Cost Output Relationship in Long run

22 Aug 201929 Sep 2024

In the Long run, all factors of production, including labor and capital,
is fixed. As a result, firms have the flexibility to adjust the scale
The cost-output relationship in the long run is significantly
output increases.

In the long run, firms make decisions about expanding or contracting

lowest possible cost per unit of output, known as minimum efficient
Long-Run Costs and Economies of Scale:

Long-Run Total Cost (LRTC)

Long-run total cost (LRTC) refers to the total cost incurred by a

in the long run, firms can adjust all costs according to the scale

Example:

A company may build a larger factory in the long run to take advantage

Long-Run Average Cost (LRAC)

Long-run average cost (LRAC) is the cost per unit of output when
presence of economies of scale at lower levels of output and diseconomies

Economies of Scale:

These occur when increasing the scale of production lowers the

Specialization of labor and management

Technological improvements

Bulk purchasing of inputs

Efficient utilization of capital

As a result, the LRAC curve slopes downward when a firm experiences

Diseconomies of Scale:

These occur when increasing the scale of production raises the

Inefficiencies in managing a larger workforce

Communication breakdowns in larger organizations

Overuse of fixed assets

When diseconomies of scale set in, the LRAC curve slopes upward.
LRAC = LRTC / Q

Long-Run Marginal Cost (LRMC)

Long-run marginal cost (LRMC) is the additional cost incurred to

change in long-run total cost by the change in output.

LRMC = ΔLRTC / ΔQ

Like the LRAC curve, the LRMC curve also has a U-shape. It initially
LRMC curve intersects the LRAC curve at its minimum point, indicating

Example of Long-Run Cost-Output Relationship

Let’s consider a firm that produces different levels of output by

long-run average cost (LRAC), and long-run marginal cost (LRMC)

Output (Q) Long-Run Total Cost (LRTC)

100 units $20,000
200 units $35,000
300 units $45,000
400 units $50,000
500 units $55,000
600 units $65,000
700 units $85,000
800 units $110,000

Analysis of the Table

Economies of Scale:

As output increases from 100 to 500 units, long-run total cost

experiences economies of scale, as the cost per unit declines, reflecting

For example, at 100 units, LRAC is $200, and at 500 units, LRAC
specialization, and spreading of fixed costs across a larger number

Minimum Efficient Scale:

The lowest point on the LRAC curve occurs at 500 units, where
is the lowest level of output at which the firm achieves minimum

Diseconomies of Scale:

As output increases beyond 500 units, the firm begins to experience

700 units, LRAC rises to $121, and at 800 units, LRAC further
of production becomes too large, leading to management and coordination

Economies and Diseconomies of Scale:

In the long run, firms can take advantage of economies of scale,

Technical Economies: As firms expand, they can use more efficient

Managerial Economies: Larger firms can afford to employ specialist

Financial Economies: Large firms often have better access to

Purchasing Economies: Firms producing on a larger scale can

However, if firms grow too large, they may experience diseconomies

like:

Managerial Inefficiency: As firms grow, it becomes harder to coordinate

Overcrowding of Resources: When too many workers or machines

Complexity in Decision Making: Larger firms often face bureaucratic

Long-Run Cost-Output Relationship and Firm’s Strategy:

The long-run cost-output relationship helps firms decide on the

to produce at the minimum efficient scale (MES) to take full advantage

Firms also use this relationship to assess whether to enter or exit

if a firm operates at a higher cost than its competitors due to diseconomies

Graph:
To draw a long-run cost curve, we have to start with a number
scale or size of the plant, including the optimum scale. One can
it touches each SAC curve at one point.

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 capital, are variable. This contrasts with the short
of production, optimize the combination of inputs,
influenced by economies and diseconomies of

contracting production capacity based on anticipated

efficient scale (MES).
 a firm when all inputs are variable. Unlike in the
of production.

advantage of lower production costs per unit, something

when a firm can adjust all its inputs. The LRAC curve
diseconomies of scale at higher levels of output.

the average cost per unit. Factors contributing to economies

experiences economies of scale.

the average cost per unit. Diseconomies may arise

upward.
 to produce one more unit of output when all inputs

initially declines due to economies of scale and

indicating the optimal scale of production.

by adjusting its plant size and capital. The table

(LRMC) for various output levels.

Long-Run Average Cost (LRAC)

$200
$175
$150
$125
$110
$108
$121
$137

cost (LRTC) increases at a decreasing rate. This

reflecting greater efficiency in production.

LRAC falls to $110. The decline in costs occurs

number of units.
 where LRAC is $110. At this point, the firm has reached
minimum long-run average cost. The firm should operate

experience diseconomies of scale. This is evident from

increases to $137. The increase in costs is a result
coordination problems, as well as overutilization

scale, which lower costs as output increases. The sources

efficient technologies or machines, reducing per-unit

specialist managers, leading to better organization

finance at lower interest rates compared to smaller

can purchase raw materials in bulk, leading to discounts

diseconomies of scale, where costs rise as output increases.

coordinate and manage all departments effectively.

machines are added to a production process, inefficiencies

bureaucratic delays, which can slow down operations

optimal scale of production and how to plan

advantage of economies of scale and minimize average

exit an industry, expand their production capacity,

diseconomies of scale, it may need to downsize or
number of short-run average cost curves (SAC curves),
can now draw the long-run cost curve which tangential

the resources such as land, labor, and capital are employed

Inputs Inputs those change or are variable in the short
Function

Production Function

output for consumption. It is the act of creating output in the

which the inputs are converted…
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 short run, where at least one input (usually capital)
inputs, and build or shut down production facilities.
of scale, which determine how costs change as

anticipated demand and costs. They aim to achieve the

 the short run, where fixed costs remain constant,

something that cannot be done in the short run.

curve typically exhibits a U-shape, reflecting the

output.

economies of scale include:

arise due to:

 inputs are variable. It is calculated by dividing the

and rises later due to diseconomies of scale. The

table below shows the long-run total cost (LRTC),

Long-Run Marginal Cost (LRMC)

–
$150
$100
$50
$50
$167
$333
$500

This results in falling LRAC and LRMC. The firm

occurs because of better utilization of resources,

 reached its minimum efficient scale (MES), which
operate at or near this level to maximize efficiency.

from the rising LRAC and LRMC. For instance, at

result of inefficiencies that arise when the scale
of inputs.

sources of economies of scale include:

unit costs.

and reduced costs.

smaller firms.

discounts and lower input costs.

increases. These diseconomies stem from issues

effectively.

inefficiencies can arise.

operations and increase costs.

plan for future expansion or contraction. Firms aim

average costs.

capacity, or introduce new technologies. For example,

or restructure to regain competitiveness.
 curves), each such curve representing a particular
tangential to the entire family of SAC curves, that is,

employed to produce a firm’s final product. To produce

short run…
the form of a commodity or a service which
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