What Is Long-Run Average Total Cost (LRATC)?
Let me explain what long-run average total cost, or LRATC, really means. It's a business metric that shows the average cost per unit of output over the long run, where you can treat all inputs as variable and adjust the scale of production as needed. The long-run average cost curve illustrates the lowest total cost to produce a specific level of output in that extended timeframe.
You should know that long-term unit costs are almost always lower than short-term ones because, over the long haul, companies like yours have the flexibility to overhaul major parts of their operations—think factories or entire production lines—to hit optimal efficiency. As someone managing a company or investing in one, your goal is to pinpoint the lower bounds of this LRATC.
Understanding Long-Run Average Total Cost
Take a manufacturing company as an example: if you build a new, larger plant, you'd assume the LRATC per unit drops below what it was at the old facility. That's because you're leveraging economies of scale—the cost advantages from ramping up production. As you expand, average costs fall, efficiency rises, and your company becomes more competitive.
This setup can result in lower prices and bigger profits, creating a win-win for consumers and producers—what economists call a positive-sum game. I'm telling you this directly: understanding LRATC helps you see how scaling impacts your bottom line.
Key Takeaways
- LRATC measures the average cost per unit of output over the long run.
- In long-term time frames, companies have more flexibility to change their operations.
How to Visualize Long-Run Average Total Cost
You can visualize LRATC as a curve that plots the lowest costs a company can achieve for any output level over time. This curve often looks similar to the short-run average total cost curve, but think of it as composed of multiple short-run curves strung together as efficiency improves. The curve breaks into three main segments.
At the start, during economies of scale, costs drop as your company grows more efficient and production expenses decrease. Those initial product development and assembly stages come with high upfront costs, but as you add factories and lines, the focus shifts to ongoing manufacturing, and repeating operations gets easier, reducing the burden.
Eventually, you'll hit constant returns to scale near peak efficiency, where raw material costs fall with bulk purchases, and production processes stabilize into a smooth rhythm. But if you keep scaling beyond that, diseconomies of scale kick in—costs rise with added bureaucracy and management layers that slow everything down. The bigger the operation gets here, the more efficiency you lose, and costs climb.
Example of Long-Run Average Total Cost
Consider the video game industry: producing a game upfront is expensive, but once it's done, making copies costs next to nothing. If your company establishes itself, grows the customer base for a game, and boosts demand, the additional output to meet that demand drives down overall costs in the long run. That's LRATC in action, showing how scaling reduces per-unit expenses over time.
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