Alright, now let's bring back the idea of the short run and the long run and talk about average total costs. So remember when we talked about the short run, the short run was where our fixed costs must remain fixed costs, right? We are going to have fixed costs in the short run, maybe some lease that we signed and we can't get out of it, right? There's always going to be some fixed costs that we can't get out of in the short run, right? So the idea here is in the short run we're going to be stuck with these decisions we made in the past, right? We've made a decision to sign this lease or to build this size factory or anything like that, right? We made these decisions and now we're stuck with them in the short run. It's not enough time for us to reevaluate these decisions and here we have a standard. I'm going to use SR for the short run and LR when we get to the long run for long run. So here on the graph, I've just put a standard short-run average total cost curve, right? This is something similar to what we've seen when we were studying average total costs and seeing the graph. I just kind of put one arbitrarily here, right? This represents that curve, right, it falls, hits a minimum, and then starts rising, right? Our average total cost in the short run. So this is kinda what we're used to.
Right? I was just kinda giving us a baseline and now I want to talk about the long run. Right? This is where the juicy stuff is. So let's go down here to our long run graph and you see a bunch of crazy stuff going on here and I wanna dive right in. So let's think about it. In the long run, which I'm going to call LR, right? LR for the long run, all our costs are variable costs, right? All our costs including those fixed costs from before, they're now variable. So you can imagine in a long enough time if we had signed a lease for a factory, that lease would expire, right, and then we could reevaluate. Should we keep this factory? Should we get a different factory, right? We could make that decision at that time or even if we built the factory ourselves, right? There's going to be a long enough time where we'll be able to just ditch the factory and build a new one or something like that, right? So in the long run, it has to do with that long time period where all our costs become variable. And just like I've been saying, we can reevaluate these big decisions like the size of our plant, size of the factory.
Right, so here we go. On the graph, you see a bunch of different curves here, right? So the idea is that in the long run, the company is reevaluating these decisions and what it gets to do is pick a short run curve, right? It gets to pick where it wants to be in the short run. So where up above we were stuck with a factory size, now we can pick a new factory size to be stuck with, right? We can build a bigger factory and then be stuck with that in the short term again, but when we think about the long term, we can pick from any of these different situations. So you can imagine that in the long run, what we get to do is pick which one of these short-run average total cost curves we want to use, right? So how big of a factory do we want to build, right?
All of these curves are short-run average total cost curves. So what happens is we're going to get to pick one, right? So what the long-run average total cost curve looks like, I'm going to draw it here in green and I'm going to do my best. Alright? So it's going to do something like this. We're going to follow these. Nope. Already messing up. Alright. Let's try one more time. It's going to kinda follow these all along here. Right? And it's going to look something like that, right? So it's going to follow all the different possible short-run curves that we can pick from, alright? And I'm going to go ahead and separate this graph into 3 sections here. So we've got this section right here. Whoops. Let me draw that again. This section here. We're going to have this section right about here and then that final section.
Okay, so let's talk about what's happening in these sections. Notice that our x-axis here, it's still quantity, right, just like we're used to and dollars, right? Some dollar amount, price, cost, right, that's going to be our y-axis. Alright, so what's happening in this first section? In this first on the left, notice that as the quantity increases, what happens to our average total cost? Our long-run average total cost, I'm going to put the average total cost decreases, right? So as we're increasing the quantity, you can see that this average cost is decreasing, decreasing, right? These numbers getting smaller and smaller as we move along in this section, right? So there's the section where quantity increases, average total cost decreases. In this next section, I didn't draw it so good but it should be pretty flat, right? That's what we see here. It's kind of a flat section. So what's happening is that as the quantity keeps increasing right from this point here, this point, this point, this point, the cost stays the same, right? We're seeing that the average total cost I'm going to put an equal sign, it's staying the same throughout that region.
And then finally in this rightmost region, we see that we're going to keep increasing quantity, but now those costs start going up again, right? The costs start increasing during this region, so we see that average total cost eventually starts increasing. Right? So this is a typical long-run average total cost curve where we're going to see that at first we're going to start decreasing our total cost as we increase quantity, we'll kinda stabilize and then it'll start increasing again, right? So let's talk about what these different sections are. The first section describes what we call average total cost decreases, right? So the cost is decreasing as the quantity goes up, right? We're producing more and more, but that average cost goes down, right? So how can that happen?
How can we be producing more units but have less total cost? Well that comes down to things we were seeing right, like ideas of specialization. When we were talking about that pizza company, right, they would add more workers and produce more output and for a small period of time there they were getting better better deals, right? They were able to produce more with those first few workers. Obviously, they hit a wall and then it started getting worse again right? But you can see that there's the value of specialization, right? We can get some value out of this where we have the economies of scale or you can see something where the costs are not increasing as quickly as the output. So you could imagine maybe economies of scale that you could get is this pizza company instead of buying say you know packets of cheese from the grocery store, now they can order this bulk amount of cheese like a whole farm's worth of cheese, right, you could imagine that they're going to get a discount, right? So they're getting these costs aren't growing as fast, right?
Even though those variable costs of the cheese for the pizza are going up, you're getting discounts and stuff, right? So you might be able to take advantage of that when you grow your output. So that could be an economy of scale or lastly, the use of large volume machinery, right? At our pizza plant in our example, they had 2 ovens that they were using, but imagine that they were going to grow extensively and they buy some oven that can cook say 50 pizzas at the same time, right? They can take advantage of these large machines that they probably couldn't in a small setting, right? So you get economies of scale there where you can use these bigger machines too. So those economies of scale, that's where we see those costs decreasing as we increase our output.
Cool. Let's go on to that second section where we're going to call it the constant returns to scale, right? And that's where we saw that it leveled off, right? Throughout this section, the second section there, you see that it's pretty flat right? It's flat and that means that we're increasing the quantity but the cost the average total cost is staying the same in this region, right? So the constant returns, we're seeing that it flattens out there and, it's a pretty simple idea there, but one point I do want to talk about is this minimum efficient scale, right? So minimum efficient scale is just basically the point where the constant returns begin. So you imagine that minimum efficient scale, it's going to be right here, right at the beginning of this section. Right? That's our minimum efficient scale.
Okay. So the it's kind of a technical term but it just basically means the point where we've exhausted all our economies of scale, right? You can imagine that all this time where the average total cost is decreasing, that's good for the business, right? We want it to decrease the cost as much as we can and then it finally levels out. So at that point we're not going to really get those benefits of increasing our quantity where the cost keeps decreasing, right? So that point is the minimum efficient scale, it's the least amount we have to produce to get the most economies of scale, right? So at that point where the constant scale begins, that's our minimum efficient scale.
Cool? So that's the quantity where the economies of scale end, right, and the constant returns begin. Minimum efficient scale is what we call it. Let's go ahead and talk about this last section where we're going to have diseconomies of scale. So you can imagine that this is going to be the opposite of the economies of scale, right? This is going to be where average total cost in the long run increase, right? Long run average total cost increases as quantity increases. So you're going to see there's going to be a point where we're going to have grown so much, our factory is so big that it actually starts to cost us more money. Our average total cost starts going up, right? And that's this last section.
You see as the quantity goes up, we're going further in quantity, higher quantities, the cost starts going up as well, right? You're seeing average total cost increasing over this section. So what could make that happen? It's mostly becomes a coordination problem with management, right? So you can imagine if we built this pizza factory, right, we built this huge pizza factory, we've got hundreds of ovens, thousands of workers right producing these pizzas, you can imagine now we're going to run into like coordination problems, right? The people preparing the pizzas, there might be like a cheese manager and each oven has an oven manager and they all have to coordinate and there's all these crazy things going on, right? So at a certain point, you could you start losing that efficiency because you've grown too much and now there's too much trouble coordinating. There's a really good example where, Henry Ford when he first produced the car, he had produced the Model T and he got serious economies of scale by taking advantage of specialization, right?
He had an assembly line where each worker had a very specific task and they were able to produce tons of cars at a very cheap price. So he saw that and he's like man, that was so great, we made so much money, let's build a gigantic factory and let's do the same thing, right? And there's stories written about this factory, he built a ginormous, ginormous like talking huge factory and there's stories where they had to hire thousands of janitors just to clean the factory, right? Now there's this huge huge problem that this factory is so big, on top of that the workers would go in there and they would see they would enter this factory and it's just so vast and there's just so many people and so much going on, they would feel intimidated. So it would actually affect their work ethic as well just because of this huge factory. So Henry Ford ended up learning a big lesson there about diseconomies of scale when he lost a ton of money.
The factory wasn't able to compete with his competitors who were able to keep costs low in their smaller factories and he soon found out that his costs were rising because how big his factory had gotten. Alright, so those diseconomies of scale come in when you're just growing too big and there's just trouble with coordination, too much management, too much going on for you to keep the cost down. Alright, so that's our discussion here about average total cost in the short run and the long run, let's go ahead and let's go to move on to the next video now. Let's do that.
