Question

A. In the long-run, a firm’s costs of production are shown by the long-run average cost curve. (12) (1) What forces explain the typical shape of the long-run average cost curve? (6) (2) How is the shape of the long-run average cost curve related to what the firms in an industry will look like? Will there be lots of firms or just a few, or perhaps even just one? Will all the firms be about the same size or will firms of different size coexist? (How do you know?) (6) B. What is the “first mover advantage” and why does the textbook call it a myth? (12)

Answer 1

1.) The long run average cost crev (LRAC) is U-shaped. This is basically because of the varying scale of production throughout the life of the industry. At the beggining, there are economies of scale to be realised as with increase in inputs, output increases more than proportionally tan average costs. This may be because of increased volume of labour and/or capital, capital efficiency, divisibility of labout and their specialisation among others. This leads to an average decrease in long run costs till a point where it becomes constant. After this point, the curve again starts increasing due to diseconomies of scale. The reasons again vary from overutilisation of capital, no more divisibility possible in labour, management issues etc. So increase in costs does not increase the average output as much leading to an upward sloping LRAC curve. Combined togehter the LRAC curve comes out to be of a U shape.

2.) The shape of the LRAC curve is related to it's constituent firms as the LRAC is a culmination of the short run average cost curves of the individual firms. If the SRAC curves have varying minimum short term average costs then the LRAC will be steep as it passes through all such points. If there are a lot of firms, the curve will be less sensitive or more "flat". If number of firms are less then the curve is more sensitive to a change in total firms and is more steep. The shape also depends on the size of indiviudal firms as one big fir might act equivalent to 3 other smaller firms in terms of short run average costs. So both the size and number of firms together decide the final shape of the LRAC.
All the advantages are given