Economies and diseconomies of scale | APⓇ Microeconomics | Khan Academy

In the last video, we were able to construct here in red this long run average total cost curve based on connecting the minimum points or the bottoms of the u's of our various short run average total cost curves. Each of those short run average total cost curves were based on a certain amount of fixed costs in the short run.

But in the long run, you can change your fixed costs, and here are fixed costs for the number of trucks. So we can vary it to optimize for a certain amount of quantity. Now, when we did that, you could see a little trend here. Especially as we go up to the way I drew it, it wouldn't necessarily be up to 200 of whatever you're producing.

But the way I drew it, you see that this part right over here looks like our long run average total cost curve is declining down. So one way to think about it is we are getting more and more efficient at producing our tacos in the long run as we produce more of them until we get to 200 tacos.

At this part of our curve, we are experiencing economies of scale. We've talked about where economies of scale can come from; it can come from specialization of labor or even machine specialization. As you get more and more scaled, you can have different parts of your process specializing in baking the taco shells or grating the cheese or cooking the meat—whatever it is.

So there's specialization. You could get better at sourcing, so as you get more scale, you might be able to order more of your supplies at a time. This way, you get better deals. You might be able to even, who knows, at some point start a farm yourself and then cut out the middlemen, and so forth and so on.

Now, as we get past that point, we see that our long run average total cost curve, at least in this example, started to trend up. So this part of the curve, you could say that we are experiencing diseconomies of scale.

What would cause diseconomies of scale? Well, these would most typically happen because of what are known as coordination issues. As an organization grows, you have more people, more resources that you have to coordinate, and that complexity can sometimes make an organization more inefficient.

There are other diseconomies of scale; at some very large scale, you might be depleting all of the low hanging fruit of your inputs. So you have to pay more for some of your inputs. Maybe you've already depleted the people who are willing to work for less, so you have to raise wages.

Or you've depleted a lot of the resources you need, so you have to find new, more expensive resources. Now, in this curve, it's not as obvious, but you can also have a notion of constant returns to scale.

So if we had a long run average total cost curve that looked something like this—let me draw it over here—then in this section right over here, as the average total cost, the long run average total cost, is going down, that would be economies of scale.

This section over here, as the long run average total cost is going up, that would be our diseconomies of scale. But this section over here, where it is constant, you might guess what that is called. That is referred—that is called constant economies of scale or constant returns to scale, sometimes known as efficient scale.