Shifts of long run average cost curves: Theoretical and managerial implications

Economists have traditionally employed one of two alternative methods when analyzing economies of scale: The long run average cost curve (LRAC curve) and the production function. Only the production function concept, however, has been extended beyond a static framework for analysis of scale economies in a dynamic setting. This paper will extend the traditional, static LRAC curve concept by developing an appropriate dynamic framework. This framework will then be used to analyze the shifts of LRAC curves through time in three major American industries: steel making, cement manufacturing, and electric power generation. The empirical and theoretical topics explored in this study raise issues of both managerial and theoretical concern. These issues include: the relationship between economic plant life and plant size; the existence of scale biases in previous studies of scale economies and current depreciation practices; the accuracy and use of construction cost indexes; and the effects of technological change over extended periods of time. The dynamic framework developed in this study serves several useful purposes. For example, it constitutes a first step toward the development of theories that fill the void between the static theory of LRAC curves and the theories of increasing, decreasing, and constant cost industries. Furthermore, many questions, such as optimal plant or firm size, should be answered in a dynamic framework if appropriate managerial or anti-trust issues are to be considered. Finally, this dynamic framework shifts the emphasis of studies of scale economies back to costs and the use of this framework should result in improved corporate planning and decision making.