What factors account for a fall in the long-run cost curve?

Economies of Scale and Long Run Average Cost (LRAC)

In the long run all costs are variable and the scale of production can change (i.e. no fixed inputs)
Economies of scale are the cost advantages from expanding the scale of production in the long run. The effect is to reduce average costs over a range of output
These lower costs represent an improvement in productive efficiency and can give a business a competitive advantage in a market. They lead to lower prices and higher profits – this is called a positive sum game for producers and consumers (i.e. the welfare of both will improve)
We make no distinction between fixed and variable costs in the long run
As long as the long run average total cost curve (LRAC) is declining, then internal economies of scale are being exploited.
The table below shows a numerical example of falling LRAC

Long Run Output (Units)Total Costs (£s)Long Run Average Cost (£ per unit)
10001200012
20002000010
5000450009
10000800008
200001440007.2
500003300006.6
1000006400006.4
50000030000006
Returns to Scale and Costs in the Long Run

The table below shows how changes in the scale of production can, if increasing returns to scale are exploited, lead to lower average costs.

Factor Inputs Production Costs
(K)(La)(L) (Q) (TC)(TC/Q)
CapitalLandLabour Output Total CostAverage Cost
Scale A534 100 325632.6
Scale B1068 300 651221.7
Scale C15912 500 976819.5
Costs: Assume the cost of each unit of capital = £600, Land = £80 and Labour = £200
Because the % change in output exceeds the % change in factor inputs used, then, although total costs rise, the average cost per unit falls as the business expands from scale A to B to C

Examples of Increasing Returns to Scale

Much of the new thinking in economics focuses on the increasing returns available to growing businesses:

An example of this is the software and computer gaming industry.

The overhead costs of developing new software programs or computer games are huge - often running into hundreds of millions of dollars
The marginal cost of one extra copy for sale is close to zero, perhaps just a few cents or pennies
If a company can establish itself in the market, positive feedback from consumers will expand the installed customer base, raise demand and encourage the firm to increase production
Because marginal cost is low, the extra output reduces average costs creating economies of scale

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