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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