8.6 Long Run Total, average & marginal costs

• In the long run, firms can adjust all inputs (labor, capital, machinery) to find the most efficient production levels. Unlike the short run, where at least one input is fixed, in the long run, a firm has full flexibility.
• Long-Run Total Cost (LTC): The minimum cost of producing a given output when all inputs can be varied. Firms seek to minimize these costs.
• Long-Run Marginal Cost (LMC): The additional cost of producing one more unit of output when a firm can adjust all inputs.
• Long-Run Average Cost (LAC): The cost per unit of output when the firm is using the optimal combination of inputs. This is the total cost divided by the output.
• The LTC curve shows the minimum cost of producing different output levels when the firm can fully adjust all inputs. This curve typically increases as more output is produced.

  Key point:

  • LTC for output = 0 is zero, meaning if the firm produces nothing, it incurs no costs.
• Long-Run Marginal Cost (LMC)

  • LMC is the increase in total cost when producing one additional unit of output.
  • In the long run, LMC reflects how efficiently a firm can scale production with full flexibility.
  • LMC tends to decrease at first due to economies of scale, but after a certain point, it may increase due to diseconomies of scale.
• LAC = LTC / Q
• The LAC curve is typically U-shaped:

  • Initially, as output increases, LAC decreases due to economies of scale.
  • After reaching a minimum point, LAC begins to increase due to diseconomies of scale.
• Marginal cost: The change in total cost when one more unit of output is produced.
• Average cost: Total cost divided by the number of units produced.
• The U-shaped LAC curve arises due to returns to scale:

  • Economies of scale: When increasing the scale of production leads to lower per-unit costs, this happens due to factors such as specialization, better use of equipment, and bulk buying of materials. This is why the LAC curve slopes downward initially.
  • Diseconomies of scale: At some point, the firm may grow too large and become inefficient. Communication breakdowns, managerial complexities, or overcrowded resources can increase per-unit costs, causing the LAC curve to slope upward.
• Why does the LAC curve have a U-shape?

  It reflects the effects of economies of scale (initial decrease in costs as production expands) followed by diseconomies of scale (increased costs as the firm becomes too large to manage efficiently).
• What happens when LMC is less than LAC?

  When LMC < LAC, the firm can reduce its average cost by increasing output.
• What is the minimum efficient scale (MES)?

  The MES is the output level where a firm’s long-run average costs are at their minimum. This is the most efficient scale for the firm to operate at.
• The LAC is U shaped : showing how average costs first decrease, reach a minimum, and then increase as output rises.
• minimum efficient scale (MES), where the firm produces at the lowest average cost
• As the firm increases output beyond the MES, average costs rise, indicating inefficiencies that lead to diseconomies of scale.
• LMC intersects LAC at the minimum point of LAC. This is where average costs are at their lowest.
• When LMC < LAC, the LAC curve is falling. This means the additional cost of producing more units is lower than the average cost, bringing down the average.
• • When LMC > LAC, the LAC curve is rising. The additional cost of producing one more unit is higher than the current average, increasing the average cost.
• • When LMC is below LAC, producing more lowers the average cost.
  • When LMC is above LAC, producing more raises the average cost.