Long Run Average Cost Theory

ANSWER 1 –

Long-run average cost refers to per unit cost incurred by an organization in the production of a desired level of output when all the inputs are variable.

The LRAC of an organization can be attained from its short-run average cost curves. Each SRAC curve represents the firm's short-run cost of production when different amounts of capital are used. The shape of the LRAC curve is similar to the SRAC curve while the U-shape of the LRAC is not due to increasing and later diminishing marginal. The -ve slope of the LRAC curve signifies economies of scale and increasing returns to scale. On the contrary, the +ve slope of the LRAC curve represents diseconomies of scale.

I completely agree with the recent development in cost theory that

In a fairly large scale of production, the long-run average cost does not rise. It may remain constant or may go on falling slightly. In case of a very large scale of production, the management cost per unit of output may rise, but the production economies more than offset the managerial diseconomies and hence the total long-run average cost does not rise or may even fall continuously at a very small rate. Thus the evidence gathered by economists in recent years does not indicate U-shaped long-run average cost curve.

Recent evidences by economists shows that initially the long-run average cost falls rapidly but after a point it remains even or at its right end it may even slope gently downward. Joel Dean (an economist best known for his contributions to Corporate Finance theory and particularly to the area of Capital budgeting) in his cost function studies finds that long run average cost curve is L-shaped.

The reasons for the LAC curve being L shaped are as follows

The meaning itself is “competition amongst few” It’s is a state of limited competition, in which a market is shared by a small number of producers or sellers. It’s a type of imperfect competition wherein there are few sellers dealing either in homogenous or differentiated products. This is also the most common market structure in most of the countries.

Features of Oligopoly are as follows –

a. Existence of few sellers - Few sellers dominate the entire industry and influence the prices of each other greatly thus controlling the market.

b. Restrictions in entry – In an oligopolistic market businesses cannot easily enter the market. Its dominated by the existing merchants/businessmen which creates imperfect competition. Restriction or barriers are lesser than monopolistic market.

c. Identical or differential products – In this type of market the production is either identical differentiated.

d. Government intervention – In oligopolistic market scenario, government plays a big role to ensure businessmen are not allowed to follow illegal ways of influencing rates and