9781118041581

advertising, and distribution. By increasing scale, the firm may be able to use

new production methods that were infeasible at smaller outputs. It also may

find it advantageous to exploit specialization of labor at the larger scale. The

result of either kind of production innovation is a reduction in long-run aver-

age cost.

Fundamental engineering relationships may have the same effect. For

instance, in 2011, Royal Caribbean International boasted the world’s largest

cruise liner, costing $1.1 billion, with capacity for 6,400 passengers and 2,300

crew. The largest cruise ships take full advantage of scale economies. At twice

the tonnage, a super-cruise liner can carry significantly more than twice the

number of passengers while requiring only a relatively modest increase in crew.

Accordingly, the cost per passenger declines markedly.

Declining average cost also may be due to the presence of a variety of fixed

expenses. Frequently, significant portions of a firm’s advertising, promotional,

and distributional expenses are fixed or (at least) vary little with the firm’s level

248 Chapter 6 Cost Analysis

Output

Long-Run Average Cost

SAC 1

SMC 2

Qmin

SMC 1 SMC 3

SAC 2

SAC 3

LMC

LMC

LAC

FIGURE 6.4

U-Shaped, Long-Run

Average Cost

The U shape is due to

increasing returns at

small outputs and

decreasing returns at

large outputs.

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