Our LRAC curve slopes downwards and then upwards.
Let’s start with the first half of our LRAC, where long run average costs decrease as the firm’s output increases.
We see this frequently in real life: when big firms expand and scale up, they’re able to drive their average costs down super low…which is how McDonalds are able to sell a cheese burgers and chips for less than £2.
It’s also how Apple are able to pack their iPhone with an HD camera, all the functionality of a computer, and thousands of apps that do everything from help users find love, get a taxi home or kill space pigs…apparently, they also make phone calls. But Apple sell its iPhones on phone contracts at just £20/month.
If Apple and McDonalds were small companies selling only a few units each year…there’s no way they’d be able to get their costs and prices down that low.
But, by scaling up and expanding, Apple and McDonalds have both successfully driven their costs down super low, by taking advantage of internal economies of scale.
Internal economies of scale reduce long run average costs, as a firm increases its production.
And there are 6 different types of internal economies of scale:
Purchasing, technical, managerial, marketing, financial and risk-bearing.
And we’ll be looking at each of these internal economies of scale next!
