Long run average cost - Definition and Overview

The long run average cost (LRAC or LAC) curve illustrates - for a given quantity of production - the average cost per unit which a firm faces in the long run (i.e. when no factors of production are fixed).

In perfect competition, the LRAC is flat - there are constant returns to scale. Typical LRACs are U-shaped, which means that up to a certain optimum point, there are economies of scale, and as production increases beyond this, there are diseconomies of scale. In some industries, the LRAC is L-shaped, and economies of scale increase indefinitely. This means that the largest firm tends to have a cost advantage, and the industry tends naturally to become a monopoly, and hence is called a natural monopoly. Natural monopolies tend to exist in industries with high capital costs in relation to variable costs, such as water supply and electricity supply.