What Is Long-Run Average Total Cost (LRATC)?Long-run average total cost (LRATC) is a business metric that represents the average cost per unit of output over the long run, where all inputs are considered to be variable and the scale of production is changeable. The long-run average cost curve shows the lowest total cost to produce a given level of output in the long run. Show
Long-term unit costs are almost always less than short-term unit costs because, in a long-term time frame, companies have the flexibility to change big components of their operations, such as factories, to achieve optimal efficiency. A goal of both company management and investors is to determine the lower bounds of LRATC. Understanding Long-Run Average Total CostFor instance, if a manufacturing company builds a new, larger plant for production, it is assumed that the LRATC per unit would eventually become lower than at the old plant as the company takes advantage of certain economies of scale or the cost advantages that come from expanding the scale of production. When the scale of production is expanded, average costs are reduced, production becomes more efficient, and a company can become more competitive in the market. This can lead to both lower prices and larger profits, which can be beneficial for both consumers and producers—this is known as a positive-sum game. Key Takeaways
How to Visualize Long-Run Average Total CostThe calculation of the LRATC may be represented as a curve showing the lowest costs that a company will be able to reach for any degree of output over time. The shape of that curve can closely resemble the curve calculated for short-run average total costs. The LRATC can be seen as made up of a series of short-run curves as a company improves its efficiency. The curve itself can be divided into three segments or phases. During the economies of scale at the beginning of the curve, costs are reduced as the company grows more efficient and its production costs diminish. The first iterations of product development and assembly carry costs that will largely be greater at the onset. As more factories and production lines are introduced, the nature of costs shifts more towards the ongoing manufacturing of the product. The burden of those expenditures diminishes as it becomes easier for the company to repeat and replicate its operations. Eventually, the company will experience constant returns to scale as it pushes closer to peak efficiency. Cost of acquisition for raw materials can be reduced by making such purchases in increasingly growing quantities. Furthermore, the processes the company uses to make its product can become more stable and streamlined as it develops a rhythm and pace for its production flow. If the company continues to scale up production, it will reach the part of the curve where diseconomies of scale become a factor and costs rise. Though a company might streamline operations, it might see new layers of bureaucracy and management introduced, which can slow overall production and decision making. The more the operation grows at this stage, the costs will rise as the operation loses efficiency. Example of Long-Run Average Total CostFor example, in the video game industry, the costs to produce a game are high. However, the cost of making copies of a game, once produced, is marginal. So, once a company can establish itself, expand the customer base for a specific game, and raise demand for that game, the extra output required to meet that demand lowers overall cost in the long run. Right on! Give the BNAT exam to get a 100% scholarship for BYJUS courses No worries! We‘ve got your back. Try BYJU‘S free classes today! The firm being able to take advantage of large-scale production techniques as it expands its output. No worries! We‘ve got your back. Try BYJU‘S free classes today! The increase in productivity that results from specialization. No worries! We‘ve got your back. Try BYJU‘S free classes today! Solution The correct option is CDiseconomies of scale.The positively sloped (i.e. rising) part of the long run average total cost curve is due to diseconomies of scaleTextbooks Question Papers Home What causes the long run average cost curve to rise?Answer: While analyzing the U-shape of a long run average cost curve, we can identify that the rising part of the LAC curve is due to both internal and external diseconomies of scale.
What happens to the long run average total cost curve?The long-run average cost curve shows the cost of producing each quantity in the long run, when the firm can choose its level of fixed costs and thus choose which short-run average costs it desires.
What is the slope of the long run average total cost curve at the quantity where a firm experiences constant returns to scale?If a firm experiences increasing returns to scale at all levels of output: the slope of its long-run average total cost curve is everywhere negative. The distance Y between the two curves in the diagram is: the total variable cost of producing five units of output.
Which curve represents the long run average total cost?The long-run average cost (LRAC) curve is a U-shaped curve that shows all possible output levels plotted against the average cost for each level. The LRAC is an “envelope” that contains all possible short-run average total cost (ATC) curves for the firm. It is made up of all ATC curve tangency points.
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