Glossary
Constant Returns to Scale
A situation where a firm's average costs remain constant as its output increases, indicating that the firm is operating at an optimal and efficient size.
Example:
A software company might experience constant returns to scale after reaching an optimal team size, where doubling output simply means doubling the number of identical teams without changing average costs.
Diseconomies of Scale
A situation where a firm's average costs increase as its output increases, typically due to challenges in managing a very large organization, such as communication breakdowns or bureaucracy.
Example:
A rapidly expanding restaurant chain might experience diseconomies of scale as coordinating operations across hundreds of locations becomes inefficient and costly.
Economies of Scale
A situation where a firm's average costs decrease as its output increases, often due to factors like specialization, bulk purchasing, or more efficient use of capital.
Example:
A large online retailer achieves economies of scale by buying shipping materials in massive quantities, significantly lowering the cost per package.
Long-Run
A period of time in which all inputs of production are variable, allowing a firm to adjust its plant size, equipment, and labor to any desired level.
Example:
A tech company deciding to build a new, larger headquarters to accommodate future growth is making a long-run decision.
Long-Run Average Total Cost (LRATC) Curve
A curve that shows the lowest possible average total cost for each level of output when all inputs are variable. It is formed by the minimum points of all possible short-run average total cost (SRATC) curves.
Example:
The LRATC curve for a smartphone company would illustrate the most efficient average cost per phone at various production scales, considering all possible factory sizes.
Long-Run Costs
Costs incurred when all inputs of production are variable, allowing a firm complete flexibility to adjust its scale of operations.
Example:
A car manufacturer planning to build a new factory to significantly increase its production capacity is considering its long-run costs.
Short-Run
A period of time in which at least one input of production is fixed, meaning a firm cannot immediately change certain factors like factory size or major equipment.
Example:
A small bakery trying to increase cupcake production by hiring more staff but without buying a new oven is operating in the short-run.
Short-Run Average Total Cost (SRATC) Curve
A curve that shows the average total cost for a firm at different output levels given a specific, fixed plant size or set of equipment.
Example:
A single SRATC curve for a small coffee shop would show its average cost per cup of coffee given its current fixed space and equipment.