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M03.L04 — Long-Run Costs: Economies and Diseconomies of Scale

Module: Module 03 — Production and Costs
Lesson: L04 of 05
Duration: ~30 minutes
Level: Introductory
Provenance: OpenStax Principles of Microeconomics 3e | MIT OCW 14.01 Principles of Microeconomics

Learning Objective

Identify why long-run average costs change with scale.

Long-Run Cost Concepts

Australian firms experience: - Economies of Scale: LRATC falls as output increases - Reasons: Specialization (BHP's mining engineers), efficient capital (Woolworths distribution), technology (CSL's vaccine production) - Constant Returns: LRATC constant - Diseconomies: LRATC rises (CBA's bureaucratic delays)

Minimum Efficient Scale (MES) is smallest output where LRATC is minimized. The LRATC curve is the "envelope" of all possible SRATC curves.

Worked Example

Australian Airline Expansion

  1. Small (Rex Airlines):
  2. High LRATC ($0.50/seat-km)
  3. Can't negotiate bulk fuel discounts
  4. Medium (Virgin):
  5. LRATC = $0.35 (economies from route optimization)
  6. Large (Qantas):
  7. LRATC = $0.30 (global maintenance hubs)
  8. Oversized:
  9. LRATC = $0.33 (diseconomies from complex logistics)

Common Misconception

"Bigger companies always have lower costs."

Actually, beyond optimal scale (like some Australian banks), coordination problems and bureaucracy can increase average costs.

Key Takeaways

  • Economies: LRATC falls with scale
  • Diseconomies: LRATC rises beyond optimal scale
  • MES is minimum efficient scale
  • LRATC envelopes SRATC curves

Practice

  1. Give three reasons for economies of scale.
  2. Why might an Australian university face diseconomies?
  3. How does LRATC differ from SRATC?

Further Resources

Provenance: OpenStax Principles of Microeconomics 3e | MIT OCW 14.01 Principles of Microeconomics