Long-run and short-run cost curves

Cost curves form a staple part of the curriculum of undergraduate microeconomics. Their
presentation across textbooks is fairly uniform and has not varied much over the years since
Marshallian partial equilibrium analysis was first codified in a set of diagrams. The uniformity
and stability of the presentation of the curves belies their controversial beginnings in the 1920s
and 30s, as economists struggled to contain Marshalls realistic descriptive insights and
biological analogies into a logically coherent static equilibrium model. In the battle that played
out between descriptive realism and neat formalisms, the latter won out for center stage in
textbook studies of cost.
Cost curves are drawn with the quantity of a specific product along the horizontal axis and
money cost on the vertical. For an analysis of perfect competition, the assumption is that each
firm faces identical input prices and choices of technology. Under this assumption, the curves
can be interpreted to correspond either to the industry as a whole, or to a representative firm.
They can represent the total cost of the quantity, the average (per unit) cost, or the marginal cost.
For the short-run, total and average costs can be broken down into the portion reflecting the
amount spent on factors of production whose quantities can be varied, and the portion reflecting
the sunk costs of the fixed factors of production. Further, one can consider long-run cost curves
drawn under the assumption that the quantities of all factors can be varied. Drawn together on
one diagram, cost curves can appear daunting to students of economics, and even their teachers
can have difficulty disentangling them in a comprehensible way. Evidence of the difficulty can
be seen in three pedagogical articles on cost curves that have appeared in the Journal of
Economic Education in recent years. (Sexton, Graves and Lee (1993), Boyd and Boyd (1994),
Silberberg (1999))
The typical textbook presentation starts with the short-run and shows the average cost curves
(total, fixed and variable) along with the marginal cost. The curves are presented in Figure 1.

Figure 1. Short-run unit cost curves: marginal cost (MC), average total cost (ATC), average
variable cost (AVC) and average fixed cost (AFC).
The short-run cost curves are normally based on a production function with one variable factor
of production that displays first increasing and then decreasing marginal productivity. Increasing
marginal productivity is associated with the negatively sloped portion of the marginal cost curve,
while decreasing marginal productivity is associated with the positively sloped portion. The
average fixed cost (AFC) curve is the cost of the fixed factor of production divided by the
quantity of units of the output, while the average variable cost (AVC) curve cost traces out the
per unit cost of variable factor of production. The U-shaped average total cost (ATC) curve is
derived by adding the average fixed and variable costs. The marginal cost (MC) intersects both
the AVC and ATC curves at their minimum points. Declining average total costs are explained
as the result of spreading the fixed costs over greater quantities and, at low quantities, the result
of the increasing marginal productivity, in addition. Increasing average costs occur when the
effect of declining marginal productivity overwhelms the effect of spreading the fixed costs.
The long-run cost curves, usually presented in a separate diagram, are also expressed most
commonly in their average, or per unit, form, represented here in Figure 2. The long-run average
cost (LRAC) curve is shown to be an envelope of the short-run average cost (SRAC) curves,
lying everywhere below or tangent to the short-run curves. The firm is constrained in the shortrun in selecting the optimal mix of factors of production and so will never be able to find a
cheaper mix than can be found in the long-run when there are no constraints. If there are a
discrete number of plant sizes available, the LRAC will be the scalloped curve obtained by
joining those parts of the SRAC curves that represent the lowest cost of production for a given
quantity.

Figure 2. The long-run average cost (LRAC) curve is an envelope curve of the short-run average
cost (SRAC) curves. Increasing, constant and decreasing returns to scale are exhibited at points
a, b and c, respectively.
In the case of constant returns to scale, the most common assumption for production functions,
the LRAC curve is horizontal. If it is the case that a larger scale of production is obtained
through increasing the number of identical plants, then the long-run cost curve approaches a
horizontal line as the number of plants increases (Joseph 1933); that is, the production function
will exhibit asymptotic-first-degree-homogeneity (Samuelson 1967, p. 131). Long-run average
cost curves that are everywhere decreasing will arise in industries with a large fixed cost and
constant variable costs. Traditionally, decreasing long-run cost curves have been associated with
natural monopolies. More generally, the LRAC curve can be drawn as a U-shape displaying
increasing returns at lower levels of output and decreasing returns at higher levels.
The long-run marginal cost curve is usually omitted in introductory treatments. If it is included,
it is drawn so that it lies above the short-run marginal cost curve to the left of their intersection
point, and below to the right. Understanding the relationship between the short-run and long-run
marginal cost curves can be challenging, and may require conjuring up additional diagrams.
Sexton, Graves and Lee (1993) couch their explanation using isocosts and isoquants; whereas
Boyd and Boyd (1994) show how the relationship can be explained using the total cost curves.
Keppler and Lallement (2006) trace the cost curve construction back to Enrico Barones 1908
Principi di economia politica. Barone presents a diagram that contains a total cost curve with
costs increasing at a decreasing and then increasing rateequivalent to the textbook U-shaped
average cost curve. He represents the marginal cost of a particular quantity as the slope of a
tangent to the cost curve at that quantity, and the average cost of a particular quantity as the slope

of a ray from the origin to the relevant point of the cost curve. Total revenue is represented on
the diagram as a line with the slope equivalent to the price. The construction allows him to
identify the profit maximizing quantity as that for which the price equals marginal cost, and the
zero profit long-run equilibrium quantity as that for which price equals both marginal cost and
average total cost .
The first U-shaped cost curve, in which cost is expressed in per unit terms, uncovered by Keppler
and Lallement (2006) appears an article by Edgeworth (1913) on railway rates. Since the
discussion was of a monopoly firm the relationship between price, marginal cost and average
cost found in Barones 1908 work is not brought out. The first per unit cost curve construction of
a firm in perfect competition bearing a close resemblance to contemporary textbook treatments,
was presented in paper by Piero Sraffa published in 1925 in an Italian language journal
(reproduced in Keppler and Lallement (2006)). Upon reading the article in Italian, Edgeworth
commissioned Sraffa to write a similar piece for the Economic Journal--which appeared in 1926
but did not contain the diagram. A virtually identical diagram, however, appears in a related
article by Pigou (1928). It is reasonable to suspect that Pigou derived it from Sraffas 1925 paper.
Roy Harrod (1931) and Jacob Viner (1931) contemporaneously published articles containing
diagrams showing the relationship between the LRAC curve and a set of SRAC curves. In his
now legendary 1931 Zeitschrift fr Nationalkonomie article, Viner had instructed his
draughtsman, the mathematican Y. K. Wong, to draw the long-run average total cost curve so
that it would run tangent to the bottoms of the short-run U-shaped curves, be downward sloping,
and nowhere lie above the short-run curves. Wong insisted that it was impossible to satisfy all
three requirements and produced a diagram with the long-run curve lying, on one portion, above
the short-run curve.
In a footnote, Viner (1931, p. 36n) admits that the diagram was in error in placing the long-run
curve above the short-run, but confesses that he did not understand Wongs mathematical reason
for it being impossible to draw the long-run curve nowhere above the short-run curves while
running along the bottoms of the short-run curves: I could not persuade him to disregard his
scruples as a craftsman and to follow my instructions, absurd though they might be. Harrod
(1959, p. 262) recounts the experience, when working on his 1931 paper at Oxford, of wandering
outside with his curves on Tom Quad in Christ Church in quest of a scientific colleague who
could tell him the proper name for the long-run curve. His quest was successful and allowed him
in the 1930s, unlike Viner, to properly describe the LRAC curve as an envelope.
In Foundations of Economic Analysis, Paul Samuelson provides a proof of what he calls the
Wong-Viner envelop theorem showing the proper relationship between constrained and
unconstrained functions. Samuelson, who had been a student in Viners class in 1935 recalls how
after admitting his error in class, Viner had told him privately after the bell had rung, that he still
thought it possible to draw a downward sloping LRAC curve that would smoothly join the
bottoms of a set of SRAC curves. In the same reminiscence, Samuelson (1972, p. 9) reports that
Schumpeter, as well, continued to be confused about the matter: He always insisted somewhere
in the third dimension of the parametrized surface of U-shaped cost curves, the envelope did go

through Viners bottom points. Silberberg (1999), noting the opacity of Samuelsons proof in
the Foundations, provides a clarifying explanation using the total cost curve diagram.
The confusion leading to the error may be related to the result from the theory of the competitive
firm that firms will produce at the minimum point on the average total cost curve after entry and
exit has driven economic profit to zero. If the price of the product (P) is such that the marginal
cost (MC) for the representative firm intersects the horizontal price line above the minimum
point on the SRAC curve, the firm will be earning economic profits and there will be entry and
expansion. As more firms enter, and as existing firms expand production, supply of the product
will increase and the price will fall. Long-run equilibrium is reached when P = MC = SRAC. If
the price intersects the marginal cost below the minimum point on the SRAC, the opposite
process of exit and contraction will reduce supply, increase the price and a new long-run
equilibrium will be established with the representative firm producing at the minimum point of
the SRAC curve.
At first sight, it seems reasonable to suppose that the points on the LRAC curve will coincide
with the minimum points on the SRAC curves, since they are the long-run equilibrium points.
The confusion is due to the conflation of two separate notions of the long-run. In Marshalls
theory of the firm in perfect competition, the long-run, or long period as he termed it, is the
hypothetical state that is achieved after economic profits have been driven to zero. The LRAC
curve, on the other hand, is tracing out the unit costs of different levels of output under the
assumption that all factors of production can be optimally adjusted. It does not refer to the longrun equilibrium of the firm and might be better labeled the unconstrained average total cost
curve. It may be a recognition of the conflation of the two notions of the long-run that lead
Schumpeter to believe that if an additional dimension was added the LRAC curve would run
through the minimum points. In any event, the confusion surrounding the curves seems to bear
out well Marshalls (1920, p. 461) warning about the limitations of the statical theory of
equilibrium in analyzing the progress of industries through time: limitations so constantly
overlooked, especially by those who approach it from an abstract point of view, that there is a
danger of throwing it into definite form at all.

References
Boyd, L. A. and D. W. Boyd (1994), The Short- and Long-Run Marginal Cost Curve: An
Alternative Explanation, Journal of Economic Education, 25 (3), 261-265.
Edgeworth, F.Y. (1913), Contributions to the Theory of Railway Rates.-IV, The Economic
Journal, 23 (90), 206-26.

Harrod, R. (1931), The Law of Decreasing Cost, Economic Journal, 41 (164), 566-576.
----------- (1959), Review of The Long and the Short, Economica, New Series, 26 (103),
260-262.
Joseph, M. F. W. (1933), A Discontinuous Cost Curve and the Tendency to Increasing Returns,
The Economic Journal, 43: 171, 390-398.
Keppler, J. H. and J. Lallement (2006), The Origins of the U-Shaped Average Cost Curve:
Understanding the Complexities of the Modern Theory, History of Political Economy, 38 (4),
733-774.
Marshall, A. (1920). Principles of Economics, 9th ed., New York: The Macmillan Company.
Pigou, A. C. (1928), An Analysis of Supply, Economic Journal, 38 (150), 238-257.
Samuelson, P. A. (1972), Jacob Viner, 1892-1970, Journal of Political Economy, 80 ( 1), 5-11
-------------------- ( 1976}, The Monopolistic Competition Revolution, in Monopolistic
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Sexton, R. L., P. E. Graves and D. R. Lee (1993), The Short- and Long-Run Marginal Cost
Curve: A Pedagogical Note, Journal of Economic Education, 24 (1), 34-37.
Silberberg, E. (1999), The Viner-Wong Envelope Theorem, Journal of Economic Education,
30 (1), 75-79.
Viner, J. (1931), Cost Curves and Supply Curves, Zeitschrift fr Nationalkonomie , 3, 23-46.