Not the Short Run

With no fixed inputs in the long run, increasing and decreasing marginal returns, and especially the law of diminishing marginal returns, are not relevant to long-run average cost. There are, however, two similar influences, economies of scale (or increasing returns to scale) and diseconomies of scale (or decreasing returns to scale).

• The Short Run: In the short run, average total cost decreases due to increasing marginal returns and increases due to decreasing marginal returns and the law of diminishing marginal returns. This triggers changes in marginal cost and thus average cost (variable and total).


• The Long Run: In the long run, there are no fixed inputs. As such, marginal returns and especially the law of diminishing marginal returns do not operate and do not guide production and cost. Instead long-run average cost is affected by increasing and decreasing returns to scale, which translates into economies of scale and diseconomies of scale.

Scale Economies

• Economies of Scale: For relatively small levels of production, a firm tends to experience economies of scale and increasing returns to scale. These result because an increase in the scale of operations (a proportional increase in all inputs under the control of the firm) causes a decrease in average cost.


• Diseconomies of Scale: For relatively large levels of production, a firm tends to experience diseconomies of scale and decreasing returns to scale. These result because an increase in the scale of operations causes an increase in average cost.

A U-shaped Curve

Long-Run Average Cost Curve

While the shape of the long-run average cost curve looks surprisingly like that of a short-run average cost curve, the underlying forces are different. This U-shape is NOT the result of increasing, then decreasing marginal returns that surface in the short run when a variable input is added to a fixed input.

The negatively-sloped portion of this long-run average cost curve reflects economies of scale and increasing returns to scale. The positively-sloped portion reflects diseconomies of scale or decreasing returns to scale.

Minimum Efficient Scale

It is not possible to produce this good in such a way that reduces the opportunity cost of foregone production, of giving up any less value from other production, than is achieved at the MES.

Two More Curves

• Long-run Total Cost: This curve graphically illustrates the relation between long-run total cost, which is the total opportunity cost incurred by all of the factors of production used in the long run by a firm to produce a good or service, and the level of production.


• Long-run Marginal Cost: This curve graphically illustrates the relation between long-run marginal cost, which is the change in the long-run total cost of producing a good or service resulting from a change in the quantity of output produced, and the level of production. It is also the slope of the long-run total cost curve.