short-run-and-long-run-relationships

Short-run and Long-run Average Costs Curves

• Day to day operations of a firm occur in the short-run

• In the long-run, they are able to plan to increase the scale of production

  • E.g by increasing the size of the factory

  • Larger scale = more output & the firm moves onto a new SRAC curve in which the average unit costs are lower

• In the long-run, a growing firm is likely to keep repeating this process,

  • Each time a more efficient SRAC is generated

• The long-run average cost curve (LRAC) is the line of best fit between the lowest points of the short-run ATC curves

The L-shaped Long-run Average cost Curve

• The L-shaped long-run average cost curve is a variation of the normal long-run average cost curve and suggests that in some instances, diseconomies of scale will not cause the LRAC to turn upwards

  • In some industries, the curve may well continue to be relatively flat

• This idea results in a loosely shaped L shaped long-run cost curve (not U-shaped)

Diagram: the L-shaped Long-run Cost Curve

Diagram analysis

• Assume a utility company spends $billions building out a new delivery network

• Their average total costs (ATC) are initially very high, but fall as they are able to gain economies of scale

• At some point, they will be operating at their lowest possible cost level (minimum efficient scale)

• They will continue operating at this level