Returns to Scale and Scope 249of output. (For instance, a 30-second television advertisement represents the
same fixed cost to a large fast-food chain and a small chain alike. But this
expense constitutes a much lower average cost per burger for the large chain.)
Similarly, the costs to firms of many government regulations are (in the main)
fixed. Accordingly, they represent a smaller average cost for the large firm. The
U.S. automobile industry, perhaps the most highly regulated sector in the
world, is a case in point.
Finally, increasing average costis explained by the problems of organization,
information, and control in very large firms. As the firm’s scale increases, so do
the difficulties of coordinating and monitoring its many management func-
tions. The result is inefficiency, increased costs, and organizational overload.^6
A great many studies have investigated the shape of average cost curves for
different industries in both the short and long runs. Almost all of these stud-
ies use regression techniques to generate equations that explain total cost as a
function of output and other relevant explanatory variables (such as wages and
other input prices). The data for this analysis can come from either a time
series (the same firm over a number of months or years) or a cross section (a
cost comparison of different firms within a single time period). Despite diffi-
culties in estimating costs from accounting data and controlling for changing
inputs (especially capital), technology, and product characteristics, these stud-
ies have produced valuable information about costs.
One general finding is that, for most goods and services, there are signifi-
cant economies of scale at low output levels, followed by a wide region of con-
stant returns at higher levels. In short, for a great many industries, long-run
average cost tends to be L-shaped, as depicted in Figure 6.5b. This is in contrast
to the usual textbook depiction of U-shaped LAC shown in Figure 6.5a. A small
number of products display continuously declining average costs. This case
usually is described under the term natural monopolyand includes many (but
not all) local utilities, local telephone service, and cable television. Figure 6.5c
shows this case.
A useful way to summarize the degree of scale economies across industries
is provided by the notion of efficient scale. Minimum efficient scale (MES)is
the lowest output at which minimum average cost can be achieved. In parts (a)
and (b) of Figure 6.5, minimum efficient scale is designated by Qmin. In part (b),
this occurs where the average cost curve first achieves a minimum. In part (c),
there is no minimum efficient scale because LAC continuously declines.
Minimum efficient scale is important in determining how many firms a
particular market can support. For example, suppose market demand is 10 mil-
lion units per year. If minimum efficient scale for the typical firm occurs at
100,000 units per year, the market can support 100 firms, each producing at(^6) For many goods and services, transportation costs are an important factor in explaining increas-
ing LAC. At a small scale, the firm can efficiently serve a local market. But delivering its good or
service to a geographically far-flung market becomes increasingly expensive.
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