Question

On what does the shape of SAC and LAC curve depend? Explain graphically along with SMC and LMC curve?

Answer 1

Shape of SAC depends on diminshing returns. Shape of LAC depends on economies and diseconomies of scale.

In above graph, the short run curve falls in the beginning, and then begins to rise.The reasons for average cost to fall in the beginning of production are that the fixed factors of a firm remain the same.

In above graph, the average cost curve is falling continuosly with the increase in the level of output, the LAC curve assumes an inverse-L shaped signifies that there are no diseconomies of scale even at very large level of output. If the average costs of production continues to fall only till a certain optimal level and beyond that it become constant then the LAC curve is roughly L-shaped and this signifies that the economies and diseconomies of product balance out each other beyond optimal level of output. In case of of an inverse J-shaped LAC curve, the LMC will lie below the LAC curve until optimal level of output is reached and coincides with LAC beyond that level of output. According to the modern theory of costs, where the fall in production costs more efficiently comprised of production and managerial costs, where the fall in production costs more than offsets the rise in managerial costs, thus the LAC curve either fall continuosly or remains constant at very large scales of output.