U-shaped Long Run Average Total Cost

Long-run average cost curve displays the organization’s lowest cost per unit at each level of output, if all factors of production are variable. The Long-run average cost curve assumes that the organization has chosen the optimal factor mix, for producing any level of output. The costs it displays are therefore the lowest costs possible for each level of output.

Reasons and Factors

Following are the reasons and factors;

  • An economy of scale, if a 10% increase in resources, brings more than proportionate increase in output.
  • Labor specialization
  • Marginal specialization
  • Efficient capital
  • Other factors
  • Diseconomies of scale, if 10% increase in resources bring less than proportionate increase in output.
  • Constant returns to scale, if a 10% increase in resources bring proportionate increase in output.

In the long run a firm can make all the necessary adjustments in all the resources like labor, plant and capacity etc. It means that can change the amount of inputs used that is why long run is called variable plant period. From the point of view of industry long run is the time period in which new firms can enter and old firm can exit or leave. The long run cost is U-shaped. Take the example of small firm that has a small plant and is producing on small scale. As a result of successful operations, it expands and built larger plants with more output capacity. As it keeps on adding plants, its long run Average total cost keeps on falling till a stage comes that adding more plants will cause the average total cost to rise. The U-shaped of long run average total cost can be explained in terms of economies and diseconomies of scale. The important point to note is this that law of diminishing returns does not apply in the long run. Because that law assumes that one resource is fixed in supply while in long run all the resources are variable.

business economics

March 12, 2019