Civil Engineering Reference
In-Depth Information
enclosed. By tradition, however, it is portrayed as being tangent to the minimum
point of the SAC curves from which it is derived. Either way, the long-run average
cost curve represents the cheapest way to produce various levels of output -
provided the entrepreneur is prepared to change the size and design of the firm's
plant. Long-run average cost curves are sometimes referred to as
planning curves
.
Why the Long-run Average Cost Curve is U-shaped
Notice that the long-run average cost curve LAC in
Figure 7.4b
is U-shaped. It is
similar to the U-shape of the short-run average cost curve developed previously
in this chapter. However, the reason for the U-shape of the long-run average cost
curve is not the same as that for the short-run U-shaped average cost curve. The
short-run average cost curve is U-shaped because of the law of diminishing marginal
returns. However, that law cannot apply to the long run - in the long run all factors
of production are variable, so there is no point of diminishing marginal returns
since there is no fixed factor of production. Why, then, does the long-run average
cost curve have a U-shape? The reasoning has to do with changes in the scale of
operations. When the long-run average cost curve slopes downwards, it means
that average costs decrease as output increases. Whenever this happens, the firm is
experiencing
economies of scale
. If, on the other hand, the long-run average cost
curve is sloping upwards, the firm is incurring increases in average costs as output
increases. The firm is said to be experiencing
diseconomies of scale
. There is a third
possibility: if long-run average costs do not change with changes in output, the firm
three stages. In the first stage the firm is experiencing economies of scale; in the
second stage, constant returns to scale; and in the third stage, diseconomies of scale.
Returns to Scale - In Three Stages
Savings (economies of scale) are possible as firms progress to larger production -
that is, increases in output can result in a decrease in average cost. There are five
types of scale economies.
•
Technical economies: relating to the firm's ability to take full advantage of the
capacity of its machinery.
•
Managerial economies: as firms grow, they can afford to employ - and benefit
from - specialised managers.
•
Commercial economies: such as buying in bulk and advertising.
•
Financial economies: larger firms have a greater variety of sources for funds and
often at favourable rates.
•
Risk bearing economies: larger firms may achieve distinct advantages by
diversifying into several markets and researching new ones.
When economies of scale are exhausted, constant returns to scale begin. Some
economists regard the commencement of this stage as the
minimum efficient scale
(MES) since it represents the lowest rate of output at which long-run average costs
are minimised - and no further economies of scale can be achieved in the present
