What is long run average cost?
Long run average cost is the cost per unit of output feasible when all factors of production are variable
Economies of Scale and Long Run Average Cost (LRAC)
The table below shows a numerical example of falling LRAC
|Long Run Output (Units)||Total Costs (£s)||Long Run Average Cost (£ per unit)|
Returns to Scale and Costs in the Long Run
The table below shows how changes in the scale of production can, if increasing returns to scale are exploited, lead to lower average costs.
|Capital||Land||Labour||Output||Total Cost||Average Cost|
|Costs: Assume the cost of each unit of capital = £600, Land = £80 and Labour = £200|
Because the % change in output exceeds the % change in factor inputs used, then, although total costs rise, the average cost per unit falls as the business expands from scale A to B to C
Examples of Increasing Returns to Scale
Much of the new thinking in economics focuses on the increasing returns available to growing businesses:
An example of this is the software and computer gaming industry.
Capacity Utilisation, Fixed Costs and Profits
Long Run Average Cost Curve