Q.The long run average cost curves are, (1) U Shaped (2) Inverted u shaped (3) V shaped (4) L- Shaped
Answer: (1). In the long run it is possible to alter all the factors of production. Thus the concept relevant to explain the shape of long run cost curve is the law of returns to scale. In the long run the fixed cost remains unchanged and the variable cost only could influence the total cost. As the level of output increases, the economies of scale works and the average cost of production decreases initially. Here increasing returns to scale is experiencing which means output is increased more than proportionally than the increase in output. This increased production combined with internal and external economies of scale, results in reduced average cost. In the second phase the curve remains constant for some levels of output (optimum level of output) as there are constant returns to scale. During this phase, output increases exactly in same proportion in which factors of production are increased. Beyond a point with further increase in output, cost curve shows an upward trend due to diminishing returns to scale or the existence of diseconomies of scale. The initial increase and further reduction in average cost results in ‘u’ shaped average cost curve.
• Phase 1: increasing returns to scale , reducing cost and downward movement of cost curve
• Phase 2: constant returns to scale and constant cost curve
• Phase 3: diminishing returns to scale , increasing cost and upward movement of cost curve