Question

The existence of both economies of scale and diseconomies of scale would have what effect on the LRAC curve?

It would make it upward-sloping.

It would make it downward-sloping.

It would give it an inverse U shape.

It would give it a U shape.

It would make it horizontal.

Answer 1

The correct option is

It would give it a U shape.

The LRAC (long run average cost curve) basically envelopes all the short run average costs. In the long run, the SRAC (short run average cost) decreases from time to time, creating the first half of the U-shaped LRAC. That is called economies of scale, which implies that as the production rises in the long run, the average cost decreases from time to time. The But, after a critical amount, the long run average cost rises, and is due to diseconomies of scale, which implies that as production rises more than the critical output, the average cost increases from time to time, which attributes to the second half of the curve. Two things should be noted - first that every point in the LRAC corresponds to the minimum of the SRAC in a period, and the second that the 'half' term used above as first half and second half should not be taken in the literal mathematical sense, but in the sense that the curve on the left of the critical point is the first half, and the curve on the right of the critical point is the second half.

The following graph summarises.