7. What is the relationship between the slope of the long-run average cost and returns to...

7. What is the relationship between the slope of the long-run average cost and returns to scale?

Expert Solution

Question 7

The long-run average cost curve is a U-shaped curve.

The U-shape implies that initially the long-run average cost curve slopes downward and after a certain level of output its slope becomes flat and further beyond a level of output it starts sloping upward.

The relationship between this shape of long-run average cost curve or more precisely the slope of the long-run average cost curve and returns to scale is that slope of LRAC curve indicates whether firm is experiencing increasing returns to scale, constant returns to scale or decreasing or diminishing returns to scale.

The downward sloping portion of LRAC curve indicates that average cost is declining as more output is produced. If firm is producing in this portion then this indicates that firm is experiencing increasing returns to scale.

The flat portion of LRAC curve indicates that average cost is constant as more output is produced. If firm is producing in this portion then this indicates that firm is experiencing constant returns to scale.

The upward sloping portion of LRAC curve indicates that average cost is increasing as more output is produced. If firm is producing in this portion then this indicates that firm is experiencing decreasing or diminishing returns to scale.

Rahul Sunny answered 2 years ago

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