Long Run Average Cost Structure

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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…show more content…
Bulk buying economies: as a firm grows in size , it needs larger raw material , with increase in raw material firm attains bargaining power over suppliers. It purchases raw material at discount which results in lower average cost of production. 2. Technical economies: firm may use advance machinery or better techniques for the production purposes. 3. Financial economies: smaller firms find it hard to obtain finance at reasonable interest rates, larger firms easily find potential lenders to raise money at lower interest rates. This capital is used to expand the production scale resulting in low average total cost 4. Marketing economies: marketing costs involved advertising & promotional costs, these costs are fixed earlier, as firm expands its capacity it can exceed the limit for marketing costs this results in low average total…show more content…
Improvement in transport and communication network. 2. 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

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