Answer
The long run average cost curve is “U” shaped. At the decreasing portion of the curve that is decreasing, the firm is experiencing economics of scale.
At the increasing portion of the curve, the firm is experiencing diseconomies of scale, where the costs increases with production. Thus, a “U” shape is derived.
The minimum efficient scale is the output where firms can produce such that their long run average cost is minimized.
If the minimum efficient scale is smaller relative to the demand of the good, there are likely to be many firms in the market (perfectly competitive). Conversely, if the minimum efficient scale is larger than the demand for the good, there is likely to be fewer firms (monopoly or oligopoly).
Work Step by Step
When experiencing economies of scale, the firm benefits from its increasing plant and production size due to more specialization and decreased cost from buying factors of production in bulk.
When experiencing diseconomies of scale due to instances such as overcrowding and increased logistical cost of transport costs, where cost would now increase with increased output.
