Long-Run Average Total Cost (LRATC)

What it is

Long-Run Average Total Cost (LRATC) is the average cost per unit of output when all inputs are variable and firms can adjust their scale of production. Formally:
LRATC = Long-Run Total Cost (LTC) / Quantity (Q)

The LRATC curve shows the lowest possible average cost of producing each output level when a firm can freely change plant size, technology, and other fixed inputs.

Why it matters

In the long run firms have greater flexibility than in the short run, so long-run unit costs are typically lower. Management and investors use LRATC to identify the most cost-efficient scale of production and to evaluate competitive positioning.

How to visualize the LRATC curve

• The LRATC curve is often drawn as the lower envelope of a family of short-run average total cost (SRATC) curves. Each SRATC represents costs with a particular fixed plant or capacity.
• As output increases, firms move to different SRATC curves that correspond to larger plant sizes or different production methods.

The LRATC curve typically has three phases:
1. Economies of scale (downward-sloping): Average costs fall as output grows. Causes include specialization, bulk purchasing of inputs, and spreading fixed costs over more units.
2. Constant returns to scale (flat): Average costs stabilize near the minimum efficient scale where scaling up neither raises nor lowers per-unit cost significantly.
3. Diseconomies of scale (upward-sloping): Average costs rise if the firm becomes too large, often due to coordination problems, increased bureaucracy, or management inefficiencies.

Practical example

In the video game industry, initial development costs are high (design, programming, testing). Once a game is complete, the marginal cost of producing additional copies is very low. As a producer expands its customer base, the average cost per unit falls—reflecting economies of scale—until other limits (marketing saturation, platform constraints, organizational complexity) slow further cost reductions.

Implications for decision‑makers

• Use LRATC to choose optimal plant size and long‑term capacity.
• Compare a firm’s current SRATC position to the LRATC to assess whether expansion or consolidation could lower costs.
• Recognize trade-offs: expanding can lower average cost up to a point, beyond which further growth may increase costs.

Key takeaways

• LRATC measures average cost per unit when all inputs are variable.
• It is the lowest average cost achievable for each output level in the long run.
• The LRATC curve reflects economies of scale, constant returns, and diseconomies of scale.