Long-run Costs

The long-run costs are derived from the production function and the prices of the inputs. No inputs are fixed in the long run, so there are no fixed costs. All costs are variable in the long run. The long run can be thought of as a series of short-run periods that reflect the cross-sections taken out of Figure. Consequently, the long run costs can be derived from a series of short-run cost functions. In principles of economics the "envelope curve" is used as an approximation of the long run average cost function In Figure, there are series of short run average cost (AC) functions shown. Each represents a different size plant. Plant size A is represented by ACA. As the plant gets larger, up to plant size ACD,, the short-run AC function associated with each larger plant size is lower and further from the vertical axis. This range is sometimes referred to as "economies of scale." Generally it happens from specialization and/or division of labour. Plant D, represented by ACD, represents the plant with the lowest cost per unit. As the plant size increases above D, the short-run average cost begins to rise. This region is often referred to as "diseconomies of scale." Lack of information to make wise production choices is usually given as the reason for the increasing cost per unit as plant size increases above plant D.

The envelope curve or LRAC is constructed by passing a line so it is smooth and just touches each of the short-run AC functions. Within each short-run period there is a short run AC, MC, AVC and AFC. The firm or plant will move from one set of short-run curves by changing the fixed input. In Figure this would be the same as moving from one cross section to another.