In: Economics
What is the long run average cost (LRAC) of a firm? How would you obtain the LRAC curve from the short run average cost (SRAC) curves? Illustrate your answer by using appropriate diagrams and underlying assumptions.
What is a long run average cost (LRAC) curve of a firm?
A long run Average cost (LRAC) curve of firms refers to a curve that shows the firms lowest cost per unit at each level of output while assuming that all factors of production are variables. That is no fixed cost involved.
The main difference between the short run Average cost and the long run Average cost Is that in the LRAC all costs are variable cost there are no fixed cost and therefore we cannot distinguish between the Total variable cost and Total cost in the long-run TC = VC.
How would you derive LRAC from the short run average cost (SRAC) curves?
To derive the LRAC from the SRAC curve, we take the lowest average total cost curve at each level of output. From the graph, The points named a,b,c are the lowest average total cost at each level adding up to the formation of the LRAC curve.
The lowest points can be of different plant size as demonstrated on graph 2.
From the graph
At output level 10 point A , the lowest point is at price $7 while at output level 20 point B, the price is 5.5 and at the output level 30, point C the price is 5 and so on to form the long-run average cost curve.