Question

The downward-sloping segment of the long-run average cost curve corresponds to a. diseconomies of scale. b. both economies and diseconomies of scale. c. the decrease in average variable costs. d. economies of scale.

Short answer

The downward-sloping segment of the long-run average cost (LRAC) curve corresponds to economies of scale, as it indicates a decrease in average cost per unit of output as production scales up. Therefore, the correct answer is \(d. \text{economies of scale}\).

Step-by-step solution

Understand the long-run average cost (LRAC) curve

The long-run average cost curve represents the average total cost of a firm over various scales of production in the long run, considering all possible combinations of factors of production. The LRAC curve can be divided into three segments: the downward-sloping segment, the constant segment, and the upward-sloping segment.

Explain economies of scale

Economies of scale refer to the cost advantages that a firm gains as it increases production. In other words, as production scale increases, the average cost per unit of output decreases. This happens because fixed costs are spread over more units of production, and there might be operational efficiencies or synergies that can be harnessed when operating at a larger scale.

Explain diseconomies of scale

Diseconomies of scale refer to the situation when an increase in the scale of production leads to a rise in average cost per unit of output. This might happen due to difficulties in managing larger operations, lack of coordination, or inefficient allocation of resources.

Identify which option corresponds to the downward-sloping segment of the LRAC curve

Comparing the concepts of economies of scale and diseconomies of scale with the segments of the LRAC curve, the downward-sloping segment indicates a decrease in average cost per unit of output as production scales up. This phenomenon represents economies of scale. So, the correct option is: d. economies of scale.

Key concepts

Economies of Scale

Imagine a company that starts increasing its production. As it does so, it begins to realize that the cost of producing each item is decreasing. This is the essence of economies of scale, a fundamental economic concept illustrating how a firm can reduce its average total cost of production as it scales up. By increasing the quantity of output, the firm can spread its fixed costs, such as rent or machinery, over a larger number of produced units. Additionally, it may benefit from volume discounts from suppliers, more efficient use of resources, and improved specialization among employees.

Understanding that the downward-sloping portion of the long-run average cost curve reflects this cost-saving scenario is crucial for students tackling production and cost analysis. In graphical terms, this concept can be visualized as the initial part of the U-shaped long-run average cost (LRAC) curve where each additional unit of output contributes to a lower cost per item.

Diseconomies of Scale

On the flip side of economies of scale lies the diseconomies of scale. Once a company grows beyond an optimal size, the costs start to creep up again, leading to an upward slope on the long-run average cost curve. The factors contributing to diseconomies of scale include management challenges due to increased operational complexity, communication breakdowns, duplication of roles, and general inefficiencies that often accompany large-scale operations.

It's important to highlight that while economies of scale focus on the cost-saving benefits of expansion, diseconomies of scale reveal the limits to growth where size becomes a hindrance rather than a benefit. Identifying and mitigating the causes of diseconomies of scale can help firms maintain an efficient balance between scale and cost.

Average Total Cost

Central to the discussion of economies and diseconomies of scale is the concept of average total cost (ATC), which is the sum of all production costs divided by the number of goods produced. It combines both variable costs, which change with the level of output, and fixed costs, which do not change with production levels. The ATC curve provides a visual representation of costs per unit of output at different production volumes.

To present a clearer picture, think of the ATC as a U-shaped curve in the long run, which initially decreases due to economies of scale, hits a minimum point, and then starts to rise due to diseconomies of scale. Familiarity with this curve is vital for students aiming to comprehend the financial implications of production decisions.

Factors of Production

Factors of production are the resources used to create goods and services and are cornerstone elements of any economic study. They include land, labor, capital, and entrepreneurship. Understanding how these factors coalesce to produce goods and services is fundamental to grasp how the long-run average cost curve is shaped.

When a business decides to alter its scale of production, whether to expand or contract, it must consider how these factors of production will be affected. For example, scaling up may require more land or machinery (capital) and additional workers (labor), which can initially lead to economies of scale. However, if expansion is not managed properly, it might result in diseconomies of scale. Therefore, recognizing how to efficiently utilize these resources is crucial for maintaining cost-effective operations and for strategic planning.