The Upward Sloping Portion of a Long-Run Average Cost Curve

A long-run average cost curve (LRAC) illustrates the relationship between the average cost of production and the quantity of output produced in the long run. The long run is a period where all factors of production, including plant size, are variable. The LRAC curve is often divided into three segments: a downward sloping portion, an upward sloping portion, and a flat or U-shaped portion.

The Upward Sloping Portion

The upward sloping portion of the LRAC curve indicates that as output increases, the average cost of production increases. This upward slope results from diseconomies of scale, which occur when the average cost of production increases as the scale of production (output level) increases.

Diseconomies of scale can arise from various factors:

Coordination and management challenges: As the size of a firm or plant increases, it becomes more complex and difficult to manage and coordinate effectively. This can lead to inefficiencies and higher costs.
Bureaucracy: Larger organizations often develop bureaucratic structures that can slow down decision-making, increase communication problems, and increase administrative costs.
Sourcing and logistics: As production increases, it may become more difficult to obtain inputs or raw materials at a reasonable cost, resulting in higher costs.
Employee turnover: Larger organizations may experience higher employee turnover rates, which can lead to training and hiring costs.
Diminishing returns to scale: In the long run, as a firm expands, it may reach a point where the marginal product of an additional unit of input decreases. This means that each additional unit of output requires more and more inputs, increasing the average cost.

Implications for Firm Size and Industry Structure

The upward sloping portion of the LRAC curve has several implications for the optimal size of firms and the structure of industries:

Firm size: The upward slope suggests that there is an optimal firm size beyond which diseconomies of scale dominate economies of scale. This optimal size varies depending on the industry and technology used.
Industry structure: Industries with upward sloping LRAC curves may exhibit a greater number of small firms instead of a few large firms. This is because diseconomies of scale limit the growth potential of firms in such industries.
Cost-based barriers to entry: The upward slope of the LRAC curve can create cost-based barriers to entry for new firms. Establishing a large-scale operation at a competitive cost can be challenging, making it difficult for new entrants to compete effectively.

Conclusion

The upward sloping portion of the long-run average cost curve reflects the presence of diseconomies of scale and provides insights into the optimal size of firms and the structure of industries. Understanding the factors that contribute to diseconomies of scale is crucial for business decision-makers and policymakers seeking to promote efficiency and competition in various industries.

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