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Long Run Cost

If you understand marginal cost, average variable cost, and average total cost in the short run, then you have the basis for understanding cost in the Long Run.

We don't use Average Total Cost for much in the short run, since it involves costs of the fixed inputs that cannot be changed in the short run. However, in the long run, average total cost is very important, since all inputs can be changed in the long run, and average total cost tells us about the costs of inputs such as captial.

In the long run, costs are all variable. This means that even capital can be altered. Output can be changed by changing both capital and labor.
We say that changing the amount of capital that a producer uses is changing its "scale"
By changing scale in the long run, a firm can pick which short run average total cost curve it wants to have.
If we drew all of the short run average total cost curves that a producer could select between, and then draw another curve containing all of these, the new curve is called the long run average total cost curve:


The long run average total cost curve slopes down (indicating lower average costs) if the scale is increased from a very small scale to a little larger scale. These declining average costs as scale is increased are called "economies of scale" or "increasing returns to scale."
As output and scale are increased, a point is reached at which greater scale no longer decreases average costs. This begins the range of output for which we say there are "constant returns to scale;" average costs neither rise nor fall as scale is increased.
Eventually, larger scale will lead to average costs getting larger. This is referred to as "diseconomies of scale," or "decreasing returns to scale."
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