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In the long-run, a firm's cost of production are shown by the long-run average cost curve
In the long-run, a firm's cost of production are shown by the long-run average cost curve.
(1) What forces explain the typical shape of the long-run average cost curve?
(2) How are the law of diminishing returns and diseconomies of scale different?
(3) 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?
(4) Will all the firms be about the same size or will firms of different size coexist? (How do you know?)
Expert Solution
1. The long-run average cost curve is the envelope of the short run average cost curves. As the latter are u shaped and LRAC is the locus of the minimum points of the SRACs, LRAC too is U shaped. So, the slopes of the minimum points of the SRACs determine the slope of the LRAC.
2. Law of Diminishing returns means as units of input rise, marginal productivity of the input rises, becomes maximum and then declines. Diseconomies of scale means as total production rises, average cost rises by greater proportion than the rise of production.
3.There could be lots of firms or just a few, or perhaps even just one. The shape of the LRAC will be independent of the number of firms.
4. Firms of same or different sizes can coexist. By looking at the production function, we can get an idea about the size of the firm.
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