Long Run Average Cost Curve Case Study
Q1. Long run cost structure of a firm is influenced by many factors, some of which are beyond the control of a manager of firm. Discuss why the long run average cost curve is U-shaped by bringing about the importance of scale economies and diseconomies. (10 Marks)
Ans: Long Run Average Cost:
• long run average cost refers to per unit cost incurred by a firm in the production of desired level of output when all the inputs are variable. The LRAC of a firm cab be obtained from its individual short term average cost curves.
• The negative slope of the LRAC curve depicts the economies of scale and increasing returns to scale. On the other hand the positive slope of the LRAC curve represents diseconomies of scale or decreasing returns to scale
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Focus on training and education within industry.
3. Support of other industries
On the other hand , diseconomies of scale refers to disadvantages that arise due to expansion of a firm’s capacity leading to a rise in the average cost of production, similar to economies of scale , diseconomies of scale can also be categorized into internal and external diseconomies of scale. o Internal Diseconomies: this refers to the diseconomies which a firm incurs due to the growth of the firm itself. This results in the decrease in the firms output and increase in the long run average cost.
The two main reasons for internal diseconomies of scale are as follows:
1. Managerial inefficiency : When a firm expands its production capacity , control and planning also needs to be increased, this requires the management to be more efficient . often due to the challenge of managing a bigger firm , managerial responsibilities are delegated to lower level personnel. Because of lack of experience of the personnel. It may result in low output at higher cost.
2. Labour inefficiency : When a firm expands it production capacity , work areas may became more crowded leaving little space for each worker to work efficiently , moreover over specialization and division of labour creates over dependence on workers. Which increase the long run average cost of
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