Generally speaking, the long run is the period of time when all costs are variable. It is not a precise period of time because it depends on the specifics of each firm.

If you have a one-year lease on your factory, then the long run is any period longer than a year since after a year, you are no longer bound by the lease. No costs are fixed in the long run. A firm can build new factories and purchase new machinery, or it can close existing facilities. In planning for the long run, a firm can compare alternative production technologies or processes.

In this context, technology refers to all alternative methods of combining inputs to produce outputs. It does not refer to a specific new invention like the tablet computer. Firms search for the production technology that will allow them to produce the desired level of output at the lowest cost. After all, lower costs lead to higher profits—at least if total revenues remain unchanged. In addition, each firm knows that if it does not seek out the lowest-cost methods of production, it may lose sales to competitor firms that find a way to produce and sell for less.

Many tasks can be performed with a range of combinations of labor and physical capital. For example, a firm can have human beings answering phones and taking messages, or it can invest in an automated voicemail system. A firm can hire file clerks and secretaries to manage a system of paper folders and file cabinets, or it can invest in a computerized record-keeping system that will require fewer employees. A firm can hire workers to push supplies around a factory on rolling carts, it can invest in motorized vehicles, or it can invest in robots that carry materials without a driver. Firms often face a choice between buying many small machines, which need a worker to run each one, or buying one larger and more expensive machine, which requires only one or two workers to operate it. In short, physical capital and labor can often substitute for each other.

Let's look at an example—a private firm that is hired by local governments to clean up public parks. In the table below, there are three different possible combinations of labor and physical capital for cleaning up a single average-sized park. The first production technology is heavy on workers and light on machines; the next two technologies substitute machines for workers. Since all three of these production methods produce the same thing—one cleaned-up park—a profit-seeking firm will choose the production technology that is least expensive, given the prices of labor and machines.

Production technology A uses the most labor and least machinery. Production technology C uses the least labor and the most machinery. The table below outlines three examples of how the total cost changes with each production technology as the cost of labor changes. Why do you think that as the cost of labor rises from example one to two to three, the firm will choose to substitute away from labor and use more machinery?

Example one shows the firm’s cost calculation when wages are $40 and machine costs are $80. In this case, technology A is the lowest-cost production technology. In example two, wages rise to $55, while the cost of machines does not change. In this case, technology B is the lowest-cost production technology. If wages keep rising up to $90—while the cost of machines remains unchanged—then technology C becomes the lowest-cost form of production, as shown in example three.

These examples show that as an input becomes more expensive—in this case, the labor input—firms will attempt to conserve on using that input and will instead shift to other inputs that are relatively less expensive. This pattern helps to explain why the demand curve for labor, or any input, slopes down; as labor becomes relatively more expensive, profit-seeking firms will seek to substitute the use of other inputs.

When a multinational employer like Coca-Cola or McDonald’s sets up bottling plants or restaurants in high-wage economies like the United States, Canada, Japan, or Western Europe, it is likely to use production technologies that conserve on the number of workers and focus more on machines. However, that same employer is likely to use production technologies with more workers and less machinery when producing in lower-wage countries like Mexico, China, or South Africa.

 

A doubling of the cost of producing the pipe allows the chemical firm to process four times as much material. This pattern is a major reason for economies of scale in chemical production, which uses a large quantity of pipes. Of course, economies of scale in a chemical plant are more complex than this simple calculation suggests, but the chemical engineers who design these plants have long used what they call the six-tenths rule—a rule of thumb which holds that increasing the quantity produced in a chemical plant by a certain percentage will increase total cost by only six-tenths as much.

New developments in production technology can shift the LRAC curve in ways that alter the size distribution of firms in an industry.

For much of the 20th century, the most common change has been to see alterations in technology—like the assembly line or the large department store—where large-scale producers seemed to gain an advantage over smaller ones. These innovations caused the downward-sloping economies of scale portion of the LRAC curve to stretch over a larger quantity of output.

However, new production technologies do not inevitably lead to a greater average size for firms. For example, in recent years some new technologies for generating electricity on a smaller scale have appeared. Traditional coal-burning electricity plants needed to produce 300 to 600 megawatts of power to exploit economies of scale fully, but high-efficiency turbines used to produce electricity from burning natural gas can produce electricity at a competitive price while producing a smaller quantity of 100 megawatts or less. This new technology created the possibility for smaller companies or plants to generate electricity as efficiently as large ones.

Another example of a technology-driven shift to smaller plants may be taking place in the tire industry. A traditional mid-size tire plant produces about six million tires per year. However, in 2000, the Italian company Pirelli introduced a new tire factory that uses many robots. The Pirelli tire plant produced only about one million tires per year, but it does so at a lower average cost than a traditional mid-sized tire plant.

Controversy has simmered in recent years over whether new information and communications technologies will increase or decrease the size of firms. On one hand, the new technology may make it easier for small firms to reach out beyond their local geographic area and find customers across a state, the nation, or even across international boundaries. This factor might seem to predict a future with a larger number of small competitors.

On the other hand, new information and communications technology might create winner-take-all markets where one large company will tend to command a large share of total sales—as Microsoft has done in the production of software for personal computers or Amazon has done in online bookselling. Additionally, improved information and communication technologies might make it easier to manage many different plants and operations across the country or around the world, which could encourage larger firms.

How developing technologies affect firm size is of great interest to economists, businesspeople, and policymakers.