Long Run Cost Curves
Long run is the period during which all inputs are variable. Thus all costs are variable in the long run (i.e. the firm faces no fixed costs). The length of time of the long run depends on the industry. In some service industries such as photocopying, the period of the long run may be only a few months or weeks.
For others, which are very capital intensive, like satellite based communication network, it may take several years. It all depends on the length of time required for the firm to be able to vary all inputs.
The Long run cost of production is the least possible cost of Production of producing any given level of output when all the inputs are variable including of course the size of the plant. A long run cost curve depicts the functional relationship between output and the long run cost of production.
Long run average cost is the long run total cost divided by the level of output. Long run average cost depicts the least possible average cost for producing all possible level of output.
In order to understand, how the long run average cost curve is derived, consider the five short run average cost curve as shown in figure.
These short run average cost curves are also called plant curves, since in the short run plant is fixed and each of the short run average cost curves corresponds to a particular plant. In the short run the firm can be operating on any short run average cost curve, given the size of the plant.
Suppose that only these five are technically possible sizes of the plants. In the long run the firm will examine that which size of the plant or on which short run average cost curve it should operate to produce a given level of output at the minimum possible cost.
In fact the long run average cost curve is locus of all tangency points with some short run average cost curves. If a firm decides to produce particular output in the long run it will pick a point on the long run average cost curve corresponding to that output and it will than build relevant plant and operate on the corresponding short-run average cost curve.
Therefore LAC is a ‘Planning Curve’ because on the basis of this curve the firm decides what plant to set up in order to produce at minimum cost the expected level of output. It is often called ‘Envelop curve’ because it envelops the SAC curves.
It can be seen from the figure that the long run average cost curve first falls and then beyond a point it rises. The U shape of LAC can be explained by the economies and diseconomies of scale. Initially when the firm increases its scale of production it reaps economies of scale.
However beyond a point, further expansion in the scale of production results diseconomies of scale.
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