When deriving the LRAC we traditionally assume that factor prices and technology remain
constant. A downward-sloping LRAC is therefore due to output increasing faster than the
proportionate increase in inputs (i.e. due to ‘technical’ or ‘real economies’ as outlined
above). A change in factor prices or technology therefore shifts the entire LRAC. Further, a
change in relative factor prices should result in factor substitution (e.g. an increase in the
price of labour relative to capital should encourage a substitution of capital for labour).
There are various sources of pecuniary economy, including the following:
Bulk buying of inputs
Larger firms can obtain discounts when purchasing large volumes of inputs: an example
is the purchasing power exerted by the large supermarkets.
External finance
Large firms can provide greater security and typically obtain finance at lower rates of
interest and on more favourable terms. They are also likely to be public companies and
have access to relatively cheaper sources of finance via the equity market. Further, when
raising capital through a share issue, the fixed administrative costs of doing so decrease
proportionally the greater the size of the share issue.
Sales and distribution
Firms advertising on a large scale can negotiate lower advertising rates. Large firms may
also be able to negotiate preferential haulage rates from distribution companies or set up
their own distribution network.
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Mini case