Long Run Average Cost

Question 1

In the Long Run firms can Move onto New Short Run Average Cost Curves

Answer 1

1. In the short run a firm has at least one fixed factor of production. This means that it operates on a particular short run average cost curve (SRAC curve) AS SEEN ON DIAGRAM PAGE 46
2. As a firm increases output in the short run by increasing variable factors of production, it moves along its short run average cost curve
3. In the long run a firm can change all factors of production. When it does this it moves onto a new SRAC curve, e.g. SRAC2.
   The MINIMUM POSSIBLE AVERAGE COST at each level of output is shown by a LONG RUN AVERAGE COST CURVE (LRAC curve).
4. SRAC curves can touch the LRAC curve, but they can’t go below it.
5. For a firm to operate on its LRAC curve at a particular level of output, it has to be using the most appropiate mix of all factors of production.
6. This means that it may not be able to reduce costs to this minimum level in the short run (since in the short run some factors are fixed).
7. But in the long run a firm can vary all factors of production and bring the costs down to the level of the LRAC curve.

Question 2

The shape of LRAC curves is determined by internal economies and diseconomies of scale

Answer 2

• Average cost falls as output increases when a firm is experiencing internal economies of scale
• Average cost rises as output increases when a firm is experiencing internal diseconomies of scale.
• Firms may face specific economies and diseconomies of scale at the same output level - whether the firm is experiencing economies or diseconomies overall will depend on which is having the greater effect.

Question 3

External Changes can cause LRAC Curves to Shift

Answer 3

• External economies of scale will cause the LRAC curve to shift downwards by reducing average costs at all output levels
• External diseconomies of scale will force LRAC curve to shift upwards.
• A change in taxation might cause the LRAC curve to shift up or down, e.g. an increase in fuel duty would cause a bus company’s LRAC to shift up.
• New technology could cause the LRAC curve to shift down if it means firms can use factors of production more efficiently at all levels, e.g. faster computers for workers.
• LOOK AT DIAGRAM PAGE 46*

Question 4

AQA Students need to know the L-shaped LRAC curve

Answer 4

1. Some economists argue that the LRAC curve is L-shaped. They claim average costs fall sharply as output increases, and then either continue to fall slowly or level off.
2. This is based on the idea that while some internal diseconomies of scale will occur with increasing output (e.g. managerial diseconomies of sclae) they’ll be offset by continued reductions in average cost due to things like production and technical economies of scale - so the LRAC curve won’t begin to curve upwards.