The Long Run Average Cost Curve
How to Construct the LR AC Curve
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Long-run Average Cost Curve
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Short Run Cost Curves
A product can be produced
in different ways by using
different combinations of
the factors of production.
For example, a product
could be made using any
given combination of the
factors as shown in the
table.
Land
Labour
Capital
Enterprise
1
15
3
1
SRAC 1
1
5
8
1
SRAC 2
1
10
5
1
SRAC 3
1
3
12
1
SRAC 4
Each of these combinations of
the factors of production would
be represented by a different
SRAC curve …
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Long-run Average Cost Curve
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Short Run Cost Curves Leading to Long Run AC Curve
AC
Each of theses SRAC curves gives a
different AC for any given quantity “X”.
SRAC 1
SRAC 2
SRAC 3
SRAC 4
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X
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Short Run Cost Curves Leading to Long Run AC Curve
between
91
180
Theany
LRAC
curve is
created
byand
combining
the
up
to 40,
41
SRAC1
90
gives
SRAC2
the
For
quantity
greater
than
180
SRAC4
SRAC3the
gives
thecost.
lowest
cost. that
segments
of each
of theaverage
SRAC
lowest
average
gives
lowest
average
cost. curves
gives the lowest average cost for all quantities.
AC
SRAC 1
SRAC 2
SRAC 3
SRAC 4
LRAC curve
40
90
180
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Short-run Cost Curves Leading to Long Run AC Curve
The same theory
holds true when
the SRAC curves
are U-shaped.
Cost
SRAC 1
SRAC 2
SRAC 3
SRAC4
Simply join the
relevant segments
of the various
SRAC curves that
give the lowest
average cost for
any given quantity.
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The Shape of the LRAC Curve
 The shape of the long run average cost curve is determined
by the interaction of the economies and diseconomies of
scale.
 Economies of scale are the forces that decrease AC as
production levels increase.
 Diseconomies of scale are the forces that increase AC as
production levels increase.
 If the economies of scale outweigh the diseconomies of scale,
AC will decrease.
 If the diseconomies of scale outweigh the economies of scale,
AC will increase.
 If they counter balance each other, AC will not change.
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Economies and Diseconomies of Scale
Economies and diseconomies of scale are
sub-divided into:
 internal economies of scale
 internal diseconomies of scale
 external economies of scale
 external diseconomies of scale.
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Internal Economies and Diseconomies of Scale
Internal economies of scale are those forces within the
firm that decrease AC as the size of the firm increases.
Internal diseconomies of scale are those forces within
the firm that increase AC as the size of the firm
increases.
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Internal Economies of Scale







Financial economies of scale.
Economies of construction.
Economies arising from specialisation of machinery.
Economies arising from specialisation of labour.
Purchasing economies of scale.
Marketing economies of scale.
Distribution economies of scale.
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Internal Diseconomies of Scale
 Managerial diseconomies.
 Lack of morale of employees.
 A high proportion of “non productive” employees.
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External Economies and Diseconomies of Scale
External economies of scale are those forces outside
the firm that decrease AC as the size of the industry
increases.
External diseconomies of scale are those forces
outside the firm that increase AC as the size of the
industry increases.
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External Economies of Scale
 Specialisation of production of components.
 As an industry expands in size more service
industries spring up around it.
 As an industry expands educational and training
institutions are established to provide the skilled
workers required by the industry.
 Specialised research and development firms will be
established to service the growing industry.
 As an industry grows the government may be
encouraged to improve the national infrastructure.
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External Diseconomies of Scale
 As an industry expands it could suffer from a
shortage of raw materials.
 As output increases in an industry the supply of the
skilled workforce required may not keep up with the
demand.
 The expansion of the infrastructure may not keep
pace with the expansion of the industry.
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Shape of Long Run AC Curve
Price
AC
AC
When economies of
scale outweigh
diseconomies of scale.
When economies and
diseconomies of scale
counter balance.
When diseconomies of
scale outweigh
economies of scale.
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Long-run Average Cost Curve
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