(Long-Run Average Cost Curve) Explain the shape of the long-run average cost curve. What does “minimum efficient scale” mean?
The long-run average cost curve (LRAC curve) is a graphical representation of the relationship between the average cost of production and the level of output in the long run. It shows the lowest average cost at which a firm can produce each quantity of output when all inputs can be varied.
The shape of the LRAC curve is often U-shaped. There are three main reasons why it has this shape:
1. Economies of Scale: Initially, as the level of output increases, a firm benefits from economies of scale. This means that the average cost of production decreases as the firm operates at a larger scale and benefits from increased specialization, efficient resource allocation, and other factors.
2. Constant Returns to Scale: Eventually, the LRAC curve reaches a minimum point, where the firm experiences constant returns to scale. At this point, the average cost remains constant regardless of the level of output. This occurs when the firm is operating at its optimal scale and can fully utilize its resources efficiently.
3. Diseconomies of Scale: Beyond the minimum point, as the firm continues to increase its scale of production, it may encounter diseconomies of scale. This means that the average cost of production starts to increase due to factors such as increased coordination difficulties, diminishing returns, and inefficiencies that arise from managing larger operations.
"Minimum efficient scale" refers to the level of output at which a firm can achieve the lowest possible average cost in the long run. It is the point on the LRAC curve where the firm is operating at its optimal scale, benefiting from economies of scale and capturing all the available cost-saving opportunities. At this scale, the firm can produce goods or services at the most efficient cost per unit, maximizing profitability. Falling below this scale would result in higher average costs, while going beyond it would lead to diseconomies of scale and increased average costs.