Y2 5) Long Run Costs and Returns to Scale (LRAC)

Summary

This video explains the concept of long-run costs and the long-run average cost (LRAC) curve, focusing on returns to scale. In the long run, all factors of production are variable, allowing businesses to scale up and experience increasing, constant, or decreasing returns to scale. The video breaks down the relationship between output changes and input changes, showing how economies and diseconomies of scale influence costs. It also introduces the minimum efficient scale (MES) as the point where average costs stop decreasing. Finally, the video touches on natural monopolies and their unique cost structures.

Takeaways

• 😀 The long run is a period where all factors of production—land, labor, capital, and enterprise—are variable, allowing businesses to scale up.
• 😀 In the long run, businesses experience returns to scale, which refers to the change in output when increasing factors of production.
• 😀 The long-run average cost (LRAC) curve is influenced by returns to scale, and it shows a U-shaped curve, reflecting increasing, constant, and decreasing returns to scale.
• 😀 Stage 1 of the LRAC curve represents increasing returns to scale, where output increases faster than input, resulting in falling average costs.
• 😀 Stage 2 of the LRAC curve represents constant returns to scale, where the percentage change in output is equal to the percentage change in input, leading to constant average costs.
• 😀 Stage 3 of the LRAC curve represents decreasing returns to scale, where output increases slower than input, resulting in rising average costs.
• 😀 Increasing returns to scale occur when the percentage change in output is greater than the percentage change in inputs, leading to a reduction in average costs.
• 😀 Decreasing returns to scale happen when the percentage change in output is less than the percentage change in inputs, leading to an increase in average costs.
• 😀 The minimum efficient scale (MES) is the lowest output level required for a business to fully exploit economies of scale and minimize average costs.
• 😀 The LRAC curve for a natural monopoly continuously slopes downward due to very high fixed costs and a long period of potential economies of scale before diseconomies set in.

Q & A

What is the long run in economics?

The long run is a period of time where all factors of production—land, labor, capital, and enterprise—are variable, meaning businesses can adjust all aspects of their production processes.

What is the primary focus of the long-run cost curve?

The long-run cost curve focuses on returns to scale, which is the change in output when all factors of production are increased. This is crucial to understanding how costs change as a business scales up.

How is the long-run average cost curve shaped?

The long-run average cost curve has a distinctive shape influenced by returns to scale. It consists of three sections: increasing returns to scale, constant returns to scale, and decreasing returns to scale.

What happens in the increasing returns to scale section?

In the increasing returns to scale section, as a business increases its inputs, it experiences a larger increase in output. This results in average costs decreasing.

What does constant returns to scale mean?

Constant returns to scale occur when the percentage change in output equals the percentage change in inputs, resulting in no change in average costs.

What happens in the decreasing returns to scale section?

In the decreasing returns to scale section, when inputs increase, the output rises, but at a slower rate than the increase in inputs, leading to an increase in average costs.

How is the percentage change in output and input calculated?

The percentage change in output or input is calculated as the difference between the new and old values, divided by the original value, and multiplied by 100.

What is the connection between returns to scale and economies of scale?

Returns to scale are closely linked to economies of scale. Increasing returns to scale typically result from economies of scale, while decreasing returns to scale are associated with diseconomies of scale.

What is the minimum efficient scale (MES)?

The minimum efficient scale (MES) is the lowest level of output required to fully exploit economies of scale, at which point average costs stop decreasing and become constant.

How does a natural monopoly's long-run average cost curve differ from others?

A natural monopoly's long-run average cost curve is typically downward sloping over a large range of output due to very high fixed costs. This results in significant economies of scale and delays in reaching diseconomies of scale.