What is Long-Run Average Total Cost ?
1101 reads · Last updated: December 5, 2024
Long-run average total cost (LRATC) is a business metric that represents the average cost per unit of output over the long run, where all inputs are considered to be variable and the scale of production is changeable. The long-run average cost curve shows the lowest total cost to produce a given level of output in the long run.Long-term unit costs are almost always less than short-term unit costs because, in a long-term time frame, companies have the flexibility to change big components of their operations, such as factories, to achieve optimal efficiency. A goal of both company management and investors is to determine the lower bounds of LRATC.
Definition
Long-Run Average Total Cost (LRATC) is a business metric that represents the average cost per unit of output over the long term, where all inputs are considered variable and the scale of production can be adjusted. The long-run average cost curve shows the lowest total cost of producing a certain level of output over the long term.
Origin
The concept of long-run average total cost originates from cost theory in economics, particularly in the early 20th century, as industrialization prompted businesses to focus on optimizing production efficiency and cost structures over the long term.
Categories and Features
Long-run average total cost can be divided into different phases: economies of scale, constant returns to scale, and diseconomies of scale. In the economies of scale phase, average costs decrease as output increases; in the constant returns to scale phase, average costs remain unchanged; and in the diseconomies of scale phase, average costs increase with output. Long-run unit costs are typically lower than short-run unit costs because companies can flexibly adjust key components of their operations over the long term to achieve optimal efficiency.
Case Studies
Case Study 1: Tesla, Inc. successfully reduced its long-run average total cost by expanding production capacity and optimizing production processes. Case Study 2: Amazon reduced its long-run average total cost and improved operational efficiency by establishing more distribution centers and optimizing its logistics network.
Common Issues
Investors often misunderstand the relationship between long-run average total cost and short-run costs, assuming they are the same. In reality, long-run average total cost considers the variability of all inputs, whereas short-run costs are constrained by fixed inputs. Additionally, determining the lower bound of LRATC is a key goal for company management and investors to maximize cost-effectiveness.
