The Firm, Profit, and the Costs of Production ‹ 111Long-Run Costs
Since all inputs are variable in the long run, discussion of production levels isn’t so
much about output per hour or day; it’s more a question of plant size or capacity.
In the short run, the firm asks, “With our current plant size, how much must we
produce today?” The long run is long enough to adjust the plant capacity so the
issue is really one of scale. The firm might ask itself, “At what scale do we want to
operate?”Long-Run Average Cost
I like to think of the firm’s short-run average costs as a snapshot of the firm’s ability to pro-
duce efficiently at the fixed plant size. Over time, the firm may grow and expand the plant
size and begin to produce efficiently, but at the larger fixed plant size, giving us another
snapshot. This process repeats itself as the firm expands or contracts and each time we
receive another short-run snapshot of average cost. If we could put these short-run snap-
shots together into a kind of motion picture, we would see a more continuous long-run
home movie of the firm’s average costs. The example and Figure 8.7 illustrate the connec-
tion between short- and long-run average costs.Example:- In year one, Molly’s firm operates at a “small” scale, producing on SRAC 1.
- In year two, Molly could expand and operate at a “medium” scale, producing on
SRAC 2 , but only if she can sell more than 100 gallons of lemonade. At quantities
below 100, SRAC 1 <SRAC 2 , so expansion would not be wise. - In year three, Molly might expand to operate at a “large” scale and move to SRAC 3 ,
but only if she can sell more than 250 gallons. - Beyond the “large” scale exists a “grande” scale, but very quickly SRAC 4 >SRAC 3
and so this plant capacity actually begins to incur rising per unit costs.
Each of these four short-run snapshots of average costs can be smoothed out into
the home movie long-run average cost curve, which is composed of sections of each
short-run average cost curve at each of the four plant sizes that Molly might choose for
her firm. In Figure 8.7, the long-run average cost curve would lie along the segments
arbrcrdre.Economies of Scale
Construction of a smoother version of Figure 8.7 allows us to see more easily some impor-
tant stages of the long-run average cost curves (Figure 8.8).- Economies of scaleare advantages of increased plant size and are seen on the down-
ward part of the LRAC curve. LRAC falls as plant size rises.
a. Labor and managerial specialization is one reason for this.
b. Ability to purchase and use more efficient capital goods also can explain economies
of scale. - Constant returns to scalecan occur when LRAC is constant over a variety of plant
sizes.
“Make sure you
can differentiate
between long-run
and short-run
curves.” —Kristy,
AP Student
KEY IDEA