[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

There is one last case to consider. Suppose that increasing all inputs in proportion
leads to a more than proportionate increase in output. Suppose, for example, that when
all inputs are increased by 20 percent, output jumps by 25 percent. This is a case of
increasing returns to scale, sometimes described as economies of scale. Big is beautiful
in this case, since average costs decline as the scale of the firm is increased.
Increasing returns to scale are common at low and moderate levels of production. As
a company expands from one plant to ten plants, it still needs only one corporate headquarters
building. Moreover, it has to pay the cost for the basic design of its plants only
once. Companies with many outlets or stores, such as McDonald’s or Wal-Mart, typically
use a very small number of store designs, whether they are opening in Florida
or Minnesota. Since these costs associated with running the firm—the overhead costs—
do not increase in proportion to the increase in production, long-run average cost
curves may be slightly downward sloping, as illustrated in Figure 6.9A.
For most firms, however, diminishing returns to scale eventually set in as production
levels become very large. As the firm increases its size, adding additional
plants, it starts to face increasing managerial problems; it may have to add layer
upon layer of management, and each of these layers increases costs. Long-run
average costs start to rise with output at high levels of output, as illustrated in
Figure 6.9B.
Yet in some industries, increasing returns to scale are possible even for very
large outputs. As the firm produces a higher output, it can take advantage of machines
that are larger and more efficient than those used by smaller firms. Software companies
may enjoy increasing returns to scale. Once the program code is written, the
firms can expand production with very little additional costs—just the costs of blank
CDs to hold the programs and the costs for distribution. At higher production levels,
the initial costs of developing and writing the software are spread over a larger
output, leading to declining average costs. If there are increasing returns to scale,
the long-run average cost curve and the marginal cost curve will be downward
sloping, as in Figure 6.9C.
COST (DOLLARS PER UNIT)
A
Long-run
average
cost curve
Marginal cost curve
COST (DOLLARS PER UNIT)
Marginal
cost curve
Long-run
average
cost curve
B
COST (DOLLARS PER UNIT)
Marginal
cost curve
C
Long-run
average
cost curve
OUTPUT
OUTPUT
OUTPUT
Figure 6.9
LONG-RUN AVERAGE COSTS
Panel A shows that with overhead costs, long-run average costs may be declining, but
they flatten out as output increases. In panel B, with managerial costs increasing with the
scale of the firm, eventually average and marginal costs may start to rise. Panel C shows
that if there are increasing returns to scale, long-run costs may be continuously falling.
SHORT-RUN AND LONG-RUN COST CURVES ∂ 145