AP® Microeconomics review sheet from Aim for Five (aimforfive.com/micro/units/3/3-3)
Unit 3 · Topic 3.3
3.3 Long-Run Production Costs
In the long run a firm can change all its inputs, including plant size, so every cost is variable. The long-run average total cost curve shows the lowest cost per unit at each output level. Its shape comes from economies of scale, constant returns to scale and diseconomies of scale.
Key terms
- long-run average total cost
- economies of scale
- constant returns to scale
- diseconomies of scale
- minimum efficient scale
The long-run average total cost curve
In the long run there are no fixed costs. A firm can build a bigger factory or a smaller one, so for each output level it picks the plant size with the lowest average cost.
The long-run average total cost (LRATC) curve shows that lowest possible cost per unit at each output level. Picture many short-run ATC curves, one for each plant size. The LRATC curve runs along the bottom of all of them, which is why it's sometimes called an envelope curve. On a graph with cost per unit on the vertical axis and output on the horizontal axis, it's usually drawn as a wide U or a curve that falls, flattens out and then rises.
Economies and diseconomies of scale
- Sources of economies of scale: workers can specialize more, the firm can use large, efficient machines that only pay off at high volume, and buying inputs in bulk is cheaper.
- Sources of diseconomies of scale: very large firms are hard to manage. Communication slows down, layers of managers add cost, and workers may feel less connected to the results.
| Section of the LRATC curve | Name | What's happening |
|---|---|---|
| Falling | Economies of scale | Output grows faster than total cost, so cost per unit falls |
| Flat | Constant returns to scale | Output and total cost grow at the same rate |
| Rising | Diseconomies of scale | Total cost grows faster than output, so cost per unit rises |
Minimum efficient scale and market structure
The minimum efficient scale (MES) is the smallest output level at which LRATC reaches its lowest point. It helps decide how many firms an industry can support.
If MES is small compared with market demand, many firms can each produce at the lowest cost, and the market can be competitive, like hair salons. If MES is huge compared with market demand, only a few firms, or just one, can reach low costs. When economies of scale continue across the whole range of market demand, one firm can supply the market more cheaply than two or more could. That's a natural monopoly, which you'll study in Unit 4.
Don't mix up the two 'returns'
Diminishing marginal returns (topic 3.1) is a short-run idea: one input changes while another is fixed. Returns to scale is a long-run idea: all inputs change together. A firm can face diminishing marginal returns in the short run and still enjoy economies of scale in the long run.
Worked examples
Try each one yourself first, then open the solution.
- Example 1Calculator allowed
Reading an LRATC table
A firm's long-run average total cost at outputs of 1,000 to 8,000 units (in steps of 1,000) is $50, $40, $32, $30, $30, $30, $33, $38. Identify the ranges of economies of scale, constant returns and diseconomies of scale, and find the minimum efficient scale. If market demand at a price of $30 is 40,000 units, how many firms can each operate at the minimum efficient scale?
Show the solutionHide the solution
- Step 1: LRATC falls from $50 to $30 between 1,000 and 4,000 units: economies of scale.
- Step 2: LRATC stays at $30 from 4,000 to 6,000 units: constant returns to scale.
- Step 3: LRATC rises from $30 to $38 after 6,000 units: diseconomies of scale.
- Step 4: MES is the smallest output with the lowest cost: 4,000 units.
- Step 5: At most 40,000 ÷ 4,000 = 10 firms can each produce at least the MES and sell everything demanded at $30.
Answer: Economies of scale up to 4,000 units, constant returns from 4,000 to 6,000, diseconomies beyond 6,000. MES = 4,000 units; the market can support up to 10 firms at MES.
- Example 2
Short-run or long-run idea? (classic trap)
A factory adds a third shift of workers on its existing machines, and output per worker falls. A student says this shows diseconomies of scale. Is the student right?
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- Step 1: Only labor changed; the machines (capital) stayed fixed. That's a short-run situation.
- Step 2: Falling extra output from adding a variable input to a fixed input is diminishing marginal returns.
- Step 3: Diseconomies of scale require all inputs, including the size of the plant, to grow together, which is a long-run idea.
Answer: No. This is diminishing marginal returns (short run), not diseconomies of scale (long run).
Common mistakes
- Explaining a rising LRATC with diminishing marginal returns. In the long run, rising average cost comes from diseconomies of scale.
- Thinking there are fixed costs in the long run. Every input, and so every cost, is variable in the long run.
- Defining minimum efficient scale as the output where LRATC starts rising. MES is where LRATC first reaches its minimum.
On the exam
- Questions often show an LRATC curve or table and ask you to name the range (economies, constant returns, diseconomies) or the minimum efficient scale.
- Be ready to link large economies of scale to natural monopoly in Unit 4.
Connected topics
Videos
Check yourself
4 questions on 3.3 Long-Run Production Costs. Pick an answer to see if you got it, and why.
| Output (units per year) | Long-run average total cost |
|---|---|
| 1,000 | $12 |
| 2,000 | $9 |
| 3,000 | $7 |
| 4,000 | $7 |
| 5,000 | $7 |
| 6,000 | $8 |
Hypothetical long-run costs for a firm
Over which range of output does the firm have economies of scale?
What is the firm's minimum efficient scale?
At a price of $7, buyers in this market want 9,000 units per year. If every firm has these costs, what is the largest number of firms that can each produce at the minimum efficient scale?
Which of the following is true in the long run?
0 of 4 answered