key term - Long-Run Average Costs

Definition

Long-run average costs refer to the average cost per unit of output when a firm can vary all of its inputs, including its capital equipment and facilities. It represents the lowest possible average cost a firm can achieve in the long run as it adjusts its production scale to the most efficient level.

5 Must Know Facts For Your Next Test

1. Long-run average costs are the lowest possible average costs a firm can achieve in the long run by adjusting its scale of production to the most efficient level.
2. Explicit costs and implicit costs both contribute to a firm's total economic costs, which are used to calculate long-run average costs.
3. Accounting profit does not consider implicit costs, while economic profit takes into account both explicit and implicit costs.
4. The shape of the long-run average cost curve is typically U-shaped, reflecting economies of scale at lower output levels and diseconomies of scale at higher output levels.
5. Firms aim to operate at the minimum point of the long-run average cost curve to achieve the most efficient scale of production.

Review Questions

• Explain how long-run average costs are related to a firm's explicit and implicit costs.
  • Long-run average costs represent the lowest possible average cost per unit of output that a firm can achieve in the long run by adjusting all of its inputs, including capital equipment and facilities. Explicit costs, such as payments for labor and raw materials, as well as implicit costs, which are the opportunity costs of using the firm's own resources, both contribute to the total economic costs that are used to calculate long-run average costs. Firms must consider both explicit and implicit costs to accurately determine their long-run average costs and make informed decisions about their production scale and efficiency.
• Describe the relationship between long-run average costs, accounting profit, and economic profit.
  • Accounting profit is the difference between a firm's total revenue and its explicit costs, while economic profit takes into account both explicit and implicit costs. Long-run average costs, on the other hand, represent the lowest possible average cost per unit of output that a firm can achieve in the long run by adjusting its scale of production. Firms that operate at the minimum point of their long-run average cost curve will have the highest economic profit, as they are able to produce at the most efficient scale and minimize their total costs. However, a firm may have positive accounting profit but negative economic profit if its implicit costs are not properly accounted for, indicating that it is not truly maximizing its profits.
• Analyze how the shape of the long-run average cost curve reflects a firm's ability to achieve economies of scale and avoid diseconomies of scale.
  • The typical U-shaped long-run average cost curve reflects a firm's ability to achieve economies of scale at lower output levels and the eventual onset of diseconomies of scale at higher output levels. At lower output levels, a firm can take advantage of specialization, bulk purchasing, and other factors to reduce its average costs per unit. However, as output increases, the firm may face constraints such as managerial complexity, transportation costs, and other factors that lead to diseconomies of scale, causing the long-run average cost curve to rise. The minimum point of the long-run average cost curve represents the firm's most efficient scale of production, where it can achieve the lowest possible average cost per unit. By operating at this optimal scale, the firm can maximize its economic profits and competitiveness in the market.

Related terms

Explicit Costs:

Explicit costs are the actual, out-of-pocket expenses a firm incurs in the production of goods or services, such as payments for labor, raw materials, and other inputs.

Implicit Costs:

Implicit costs are the opportunity costs of using the firm's own resources, such as the owner's time and the use of the firm's capital equipment, which do not involve an actual cash outlay.

Accounting Profit:

Accounting profit is the difference between a firm's total revenue and its explicit costs, representing the firm's financial gain or loss from its operations.