7.12 : Economies of Scale

A firm may experience economies of scale in the long run. This occurs when a firm's output increases, but its total costs increase at a slower rate. For example, the firm may spend only 50 percent more in total cost to double the level of output. This means that the long run average cost decreases. This effect is illustrated by the downward slope of the long-run average cost curve, indicating that larger production capacity enables a firm to become more cost-efficient.

Several reasons could explain this reduction in long run average cost at higher levels of production. A software development company, for example, might invest in sophisticated software development tools and platforms that automate various stages of coding, testing, and deployment. This reduces the need for manual intervention, significantly reducing costs.

Another reason could be lower finance costs. As the firm grows and establishes a track record of profitability and reliability, its creditworthiness may improve. This could lead to more favorable financing terms, including lower interest rates on any borrowed capital, reducing the overall cost of financing.