Question

1. Draw a long-run average cost curve, carefully explain how it is derived, and explain why it has the shape that it has.

Please show me your thought process. Please explain it as if you are telling it to someone who has no clue about economics.

Answer 1

Answer: Long run average cost curve : in long run all firms have variable inputs and there is a minimum cost of producing each level of output.

First let's understand the short run Averege cost SRAC . In short run a firm can operate in any SAC with given size of plant. But in long run,a firm will examine each SAC to find the curve with minimum cost producing a given level of output.

If a firm has a set of choice of varing a plant infinitely which leads to infinite averege cost curve. In that case, smooth curve which is envolving all these SRAC curve is a long run average cost curve .

Every point on Long run average cost curve is tangent to short run averege cost curve.

LRAC curve will not be tangent to minimum of SRAC . It will be tangent to falling part of AC when it is decling .

And LRAC is tangent to rising part of AC when it is rising

It has U shaped

Reason for U shaped curve : 1 .this shape is totally depends on return to scale. When output will increase or firm expands, return to scale will increase.

2. LRAC curve has a negative relation with return to scale.

*When LRAC is decling, return to scale will increase OR economics of scale will increase because of internal and external economics of scale .

* when LRAC is increasing ,returns to scale or economics of scale will decrease and we get dis economies of scale that's means negative return. Cost is higher than output .