What are long-run costs?

Long-run costs are accumulated when firms change production levels over time. In the long-run firms can overcome diminishing returns because in the long-run all factors of production are variable. There are no fixed factors of production in the long-run.

Returns to Scale

Returns to scale exists in the long-run, it affects the shape of a firm's average cost curve.

We can break down returns to scale in three categories:

1) Increasing returns to scale: When % change in output is greater than % change in inputs.

2) Decreasing returns to scale: When % change in output is less than % change in inputs.

3) Constant returns to scale: When % change in output is equal to % change in inputs.

Returns to Scale & Economies of Scale

Returns to scale and economies of scale are closely related concepts. The reasons we have increasing returns to scale is because of economies of scale. When a firm employs economies of scale it will benefit from increasing return to scale.

Equally when a firm experiences diseconomies of scale a firm will suffer from decreasing returns to scale.

Minimum Efficient Scale (MES)

The MES corresponds to the lowest point on the long-run AC curve. It is the lowest scale necessary to achieve the economies of scale required for a firm to operate efficiently and competitively.



The output required to reach the MES will depend on the nature of the industry:

Large industry = large output = high costs = small number of firms.

Small industry = small amount of output = low cost = large number of firms.