If the firm wishes to produce output Q1, then it could do so by:
œ using SRAC1 with an average cost per unit of C3, and producing above capacity;
œ using SRAC2 with an average cost of C2, and producing at optimum capacity; or
œ using SRAC3 with an average cost of C1, and producing with excess capacity.
The envelope of the short-run curves denotes the long-run average cost curve (LRAC).
In this case the long-run curve has a scalloped shape. Increased divisibility of the fixed
factors would provide a larger number of short-run curves and the LRAC becomes
smooth, as illustrated in Figure 5.10.
From Figure 5.10 we observe that as the firm increases the scale of output to Q1 then
increasing returns to scale (or economies of scale) are achieved. Beyond Q1 we have
decreasing returns to scale (or diseconomies of scale). At Q1, scale economies are
exhausted and long-run average costs of production are minimised. At this point the
corresponding SRAC is at optimum capacity.With a smooth LRAC, any output less than
Q1 must correspond to a point on a SRAC with excess capacity, and beyond Q1 to a
point on a SRAC above capacity.
Figure 5.10 also shows the long-run marginal cost curve (LRMC) corresponding to the
LRAC. This cuts the LRAC at its minimum point and has the same relationship to LRAC
as a short-run MC to a corresponding SRAC. If the firm were to experience constant
returns to scale over a given range of output (see Figure 5.11), LRAC and LRMC coincide.
If, in Figure 5.11, the firm produces at an output between Q1 and Q2, it is fully exploiting
scale economies and producing optimally. Such optimality could therefore be achieved
with a range of plant sizes.With a U-shaped LRAC (see Figure 5.10), there is a single optimal
level of output and therefore a single optimal scale of plant. When producing at
minimum LRAC the firm is said to be producing at minimum efficient scale (MES).