Average Total Cost: Short Run and Long Run: Videos & Practice Problems

In economics, understanding average total costs (ATC) is crucial for analyzing short-run and long-run scenarios. In the short run, fixed costs remain constant, leading to a typical U-shaped ATC curve. Conversely, in the long run, all costs become variable, allowing firms to choose optimal production levels. The long-run ATC curve illustrates three phases: decreasing costs due to economies of scale, constant returns to scale, and increasing costs from diseconomies of scale. Key concepts include minimum efficient scale and the impact of coordination problems on production efficiency.

ATC in the Short Run and Long Run

Understanding the concepts of short run and long run average total costs is crucial in economics, particularly when analyzing production decisions. In the short run, certain costs are fixed, meaning businesses cannot adjust them immediately. For instance, a company may have signed a lease for a factory that cannot be changed in the short term. This leads to a situation where businesses must operate within the constraints of their existing decisions, which are represented graphically by the short run average total cost (SRATC) curve. This curve typically shows a U-shape, indicating that average total costs initially decrease as production increases, reach a minimum point, and then begin to rise again.

In contrast, the long run is characterized by the flexibility to adjust all costs, including those previously considered fixed. Over time, businesses can reevaluate their production capacity, such as the size of their factory or the scale of their operations. The long run average total cost (LRATC) curve reflects this flexibility and is derived from various short run average total cost curves. As firms grow, they can choose the most efficient short run curve that aligns with their production goals.

The LRATC curve can be divided into three distinct sections. In the first section, as production quantity increases, average total costs decrease. This phenomenon is often attributed to economies of scale, where increased production leads to lower per-unit costs due to factors like specialization, bulk purchasing, and the use of larger, more efficient machinery. For example, a pizza company might benefit from buying ingredients in bulk, reducing costs as production scales up.

The second section of the LRATC curve represents constant returns to scale, where average total costs remain stable despite increases in production. This section begins at the minimum efficient scale, which is the output level at which a firm has fully exploited its economies of scale. Beyond this point, the firm can produce additional units without increasing average costs.

Finally, the last section of the LRATC curve illustrates diseconomies of scale, where average total costs begin to rise as production continues to increase. This can occur due to coordination challenges within a larger organization, leading to inefficiencies. A historical example is Henry Ford's experience with his massive factory, where the complexity of managing a large workforce and facility resulted in increased costs and reduced competitiveness.

In summary, the relationship between production quantity and average total costs varies significantly between the short run and long run. Understanding these dynamics helps businesses make informed decisions about scaling operations and managing costs effectively.

A short-run production function assumes that

• A. The level of output is fixed
• B. The usage of at least one input is fixed
• C. All inputs are fixed inputs
• D. Both (a) and (b)
• E. Both (b) and (c)

Answer: (B)

Which of the following is TRUE?

• A. A firm plans in the short run and operates in the long run
• B. In the long run, a firm can change all but one input
• C. In the long run, all inputs are variable
• D. In the short run, all inputs are fixed

Answer: (C)

If a higher level of production allows workers to specialize in particular tasks, a firm will likely exhibit ______________ and ________________ average total cost.

• A. Economies of Scale; Falling
• B. Economies of Scale; Rising
• C. Diseconomies of Scale; Falling
• D. Diseconomies of Scale; Rising

Answer: (A)

Here’s what students ask on this topic:

What is the difference between short-run and long-run average total cost curves?

In the short run, some costs are fixed, leading to a U-shaped average total cost (ATC) curve. This curve initially decreases due to spreading fixed costs over more units, hits a minimum, and then rises due to diminishing marginal returns. In the long run, all costs are variable, allowing firms to adjust all inputs. The long-run ATC curve is derived from the lowest points of various short-run ATC curves and typically has three phases: decreasing costs due to economies of scale, constant returns to scale, and increasing costs from diseconomies of scale. This flexibility allows firms to choose the most efficient production level.

What are economies of scale and how do they affect the long-run average total cost curve?

Economies of scale occur when increasing production leads to lower average total costs. This happens because fixed costs are spread over more units, and firms can take advantage of bulk purchasing, specialized labor, and more efficient machinery. In the long-run average total cost (LRATC) curve, economies of scale are represented by the downward-sloping section. As output increases, the LRATC decreases, reflecting cost savings. This phase continues until the firm reaches the minimum efficient scale, where the cost per unit is at its lowest.

What is the minimum efficient scale and why is it important?

The minimum efficient scale (MES) is the smallest quantity of output at which a firm can achieve the lowest long-run average total cost (LRATC). It marks the point where economies of scale are fully exploited, and constant returns to scale begin. MES is crucial because it indicates the optimal production level for minimizing costs. Firms operating below this scale may face higher costs, while those operating above it may encounter diseconomies of scale, where costs start to rise due to inefficiencies and coordination problems.

How do diseconomies of scale impact the long-run average total cost curve?

Diseconomies of scale occur when increasing production leads to higher average total costs. This typically happens due to coordination problems, management inefficiencies, and overburdened resources. In the long-run average total cost (LRATC) curve, diseconomies of scale are represented by the upward-sloping section. As output increases beyond a certain point, the LRATC rises, reflecting the increased costs. This phase highlights the limits of growth, where expanding production further becomes less efficient and more costly.

Why is the short-run average total cost curve U-shaped?

The short-run average total cost (ATC) curve is U-shaped due to the interplay of fixed and variable costs. Initially, as production increases, fixed costs are spread over more units, causing the ATC to decrease. This is the downward-sloping part of the curve. However, as production continues to increase, diminishing marginal returns set in, meaning each additional unit of input contributes less to output. This leads to rising variable costs, causing the ATC to increase, forming the upward-sloping part of the curve.