Long-Run Costs and Economies of Scale

Categories: Accounting, Econ

Long-run costs are big, “one-time”-ish costs. For you, that might be a car, a house, or a child. For a firm, it might be a factory and equipment. Long-run costs contrast with short-term costs, which are costs you pay on the reg. For you, that’s groceries and utilities. For firms, that’s employees wages and the inputs that turn into outputs, like raw materials.

Understanding long-run and short-run costs are necessary to really understand how economies of scale work. Economies of scale is the main reason that big companies are putting all of the little guys out of business. The reason Amazon, Walmart, and Costco are flourishing like daisies.

Economies of scale describes the phenomenon where, as output increases, the marginal cost (think: cost per thing made) go down. For instance, there’s economies of scale when you’re making cookies in your kitchen. You could get out the flour, the chocolate chips, etc. and make one cookie in a mug (yeah, you can do this)...or, you could just make an entire batch of cookies. Thinking purely in the cost of your time, it might take you 20 minutes to make one cookie in a mug, or 30 minutes to make two dozen cookies. That’s the magic of economies of scale.

Why does this happen? The average costs for a firm go down as more output is made. While short-run costs have to be paid on the reg, long-run costs were already paid for: the gift that keeps on giving. This makes the long-run average cost go down, down, down.

Drop that long-run average cost to the floor.

Related or Semi-related Video

Econ: What are Marginal Product and Dimi...8 Views

00:00

And finance Allah shmoop what are marginal product and diminishing

00:06

returns All right people when you're running a business you

00:10

invest in your inputs everything from large fixed costs like

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that robot assembly unit there to labor with human beings

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and or dogs In return for your inputs you get

00:22

output But how do you know if it's worth it

00:24

or not Adm Or of a given input finding the

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marginal product of an input can help you answer this

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excellent question Well the marginal product of an input whether

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it be physical inputs or labour is the increasing output

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as a result of one additional unit of that input

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Okay let's make sense of this to see what we

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mean Let's take a look at Black Beard who for

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having a very short pirating career is nonetheless known for

00:48

being a decent manager of his crew At first Black

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Beard had a small crew because his crew was small

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Their rum booty was also pretty small They couldn't battle

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big ships that were holding the most gold and they

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could only carry so much of it even when they

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won in stolen well black Beard hired another pirate which

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increased their total booty from a thousand pieces of eight

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to thirteen hundred pieces of eight since the booty went

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from a thousand of thirteen hundred thanks to the additional

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of that new employees will The marginal product of that

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new hire was three hundred pieces of eight and if

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he cost less than three hundred pieces of aid right

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he was a bargain At least he was positive The

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results of another mate in the crew were so great

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that black beard decided to hire another pirate and then

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another and then another Well even though the marginal product

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with each new input of labor was less than last

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he kept hiring more pirates Since each new pirate was

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still contributing positively to Ah hire total output well with

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a bigger crew they were able to take on bigger

01:43

ships increasing their total output All other inputs like their

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pirate ships stayed constant It was the same ship as

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the crew's size increased Well so did the amount of

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booty they were scoring and who doesn't like to score

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booty But the law of diminishing returns has a way

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of making it rain on everyone's parade The law of

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diminishing returns pops up in many places in economics including

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marginal product like right here while increasing a marginal product

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like labor for instance will increase total output for awhile

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Eventually additional units of that input will result in a

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stagnant or decreased total output Well after Black Beard's most

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recent pirate higher alluding went terribly wrong There were so

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many pirates on his ship that they couldn't loot effectively

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They were bumping into each other accidentally shooting each other

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right in the head or worse and they were frustrated

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because of it Well all of a sudden they're total

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output Their booty dropped from three thousand pieces of eight

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to only twenty five hundred pieces of eight Argh Yeah

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that's what they said Well in Black Beard's case his

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output was initially increasing as he grew his crew but

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eventually decreased because of it The last pirate he hired

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had a negative marginal product of five hundred pieces of

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eight Since that last additional unit of labor input caused

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total output to go from three thousand pieces of eight

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to twenty five hundred piece of aid or something that

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was just making So what's a pyre to do Well

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he could get another ship and start a franchise or

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a fleet Or he could let that last pirate walk

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the plank and just stick with one ship and his

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given number of pirates A zit is well the more

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the merrier Up to a point Ask any pirate and

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