Long run average cost
The long run average cost (LRAC or LAC) curve illustrates - for a given quantity of production - the average cost per unit which a firm faces in the long run (i.e. when no factors of production are fixed).
LRAC curve is derived from a series of short run average cost curves. It is also called the 'envelope curve' since it envelops all the short run average cost curves.
In perfect competition, the LRAC curve is flat, at the point of equilibrium- there are constant returns to scale. Typical LRACs are U-shaped, which means that up to a certain optimum point, there are economies of scale, and as production increases beyond this, there are diseconomies of scale. LRAC are generally flatter than short run average cost curve.
In some industries, the LRAC is L-shaped, and economies of scale increase indefinitely. This means that the largest firm tends to have a cost advantage, and the industry tends naturally to become a monopoly, and hence is called a natural monopoly. Natural monopolies tend to exist in industries with high capital costs in relation to variable costs, such as water supply and electricity supply.
The Longrun average cost curve.
The longrun average total cost curve is derived from the points of tangency of many shortrun cost curves. The longrun average cost curve is also called the "Envelope" curve" because it comprises and encloses several shortrun average cost curves.
The longrun ATC curve is tangent to the shortrun ATC curves before their minimum points when LATC is falling. LATC curve is however tangent to the shortrun ATC curves at their minimum when it is rising
In the shortrun when a firm establishes one plant, it will definitely operate at a high cost (OC1) and produce a low level of output (Q1)
When the demand for its product increases, the firm will be encouraged to establish more plants which will operate at a lower cost of production due to economies of scale. The cost of production will fall to OC3 and output increase to Q3.
However, if the firm continues to establish many new plants beyond a certain point, some of the plants will start to operate at an increasing average cost of production due to diseconomies of scale i.e OC4.
The longrun ATC curve is U-shaped and sometimes also known as the planning curve. It is a planning curve because the decision of a firm to expand its scale of production depends on the longrun ATC curve.
Note: the average cost curve is U-shaped in the longrun because of the law of returns to scale i.e economies and diseconomies of scale. While the shortrun average cost curve is U-shaped because of the law of diminishing returns.
LRAC curve is derived from a series of short run average cost curves. It is also called the 'envelope curve' since it envelops all the short run average cost curves.
In perfect competition, the LRAC curve is flat, at the point of equilibrium- there are constant returns to scale. Typical LRACs are U-shaped, which means that up to a certain optimum point, there are economies of scale, and as production increases beyond this, there are diseconomies of scale. LRAC are generally flatter than short run average cost curve.
In some industries, the LRAC is L-shaped, and economies of scale increase indefinitely. This means that the largest firm tends to have a cost advantage, and the industry tends naturally to become a monopoly, and hence is called a natural monopoly. Natural monopolies tend to exist in industries with high capital costs in relation to variable costs, such as water supply and electricity supply.
The Longrun average cost curve.
The longrun average total cost curve is derived from the points of tangency of many shortrun cost curves. The longrun average cost curve is also called the "Envelope" curve" because it comprises and encloses several shortrun average cost curves.
The longrun ATC curve is tangent to the shortrun ATC curves before their minimum points when LATC is falling. LATC curve is however tangent to the shortrun ATC curves at their minimum when it is rising
In the shortrun when a firm establishes one plant, it will definitely operate at a high cost (OC1) and produce a low level of output (Q1)
When the demand for its product increases, the firm will be encouraged to establish more plants which will operate at a lower cost of production due to economies of scale. The cost of production will fall to OC3 and output increase to Q3.
However, if the firm continues to establish many new plants beyond a certain point, some of the plants will start to operate at an increasing average cost of production due to diseconomies of scale i.e OC4.
The longrun ATC curve is U-shaped and sometimes also known as the planning curve. It is a planning curve because the decision of a firm to expand its scale of production depends on the longrun ATC curve.
Note: the average cost curve is U-shaped in the longrun because of the law of returns to scale i.e economies and diseconomies of scale. While the shortrun average cost curve is U-shaped because of the law of diminishing returns.