The long-run average cost of a good is the total cost needed to produce one more unit divided by the number of units that have been produced so far.
It’s used when managers set normal long-run prices for goods, which are typically done through marginal analysis.
The first step in this process is determining the short-run average cost per unit.
Then calculating how many extra units will be sold if pricing were increased or decreased by some amount.
It’s then possible to assume the long-run average cost of one more unit.
What it would be if pricing were increased or decreased?
The short-run is when managers are setting prices in order to keep their production levels at a certain level for some time.
The long-run is when they have enough information about costs to set prices that will allow them to make as much profit as possible over the long term.
One important note on both approaches:
There needs to be an understanding of how price changes affect demand so that wrong assumptions don’t lead people astray.
For instance, raising prices may reduce demand because customers feel like they’re being priced out.
While lowering prices may increase demand because it makes products seem cheaper than competitors’.