Question

9. The following diagram shows the long-run average and marginal cost curves for a firm. AC SMC (K = 150) MC SMC (K=300 It also shows the short-run marginal cost curve for two levels of fixed capital: K = 150 and K=300. For each plant size, draw the corresponding short-run average cost curve and explain briefly why that curve should be where you drew it and how it is consistent with the other curves.

Answer 1

9. The following diagram shows the long-run average and marginal cost curves for a firm. AC SMC (K = 150) SAC,MC SAC2

The SAC curves are the green curves shown below. Each curve must satisfy two requirements --

(1) the SAC curve must be tangent to the AC curve at the output level at which the corresponding SMC curve crosses the LMC curve; and

(2) the SAC curve must reach a minimum at the output level at which it intersects its own SMC curve.

SAC2 is tangent to AC at SAC2’s minimum level. This is because the point where SMC2 crosses MC is the minimum point of LAC. We know this because this is where MC crosses AC.

SAC1 is not tangent to AC at SAC1’s minimum point since the point where SMC1 crosses MC is not the minimum point of AC. So for SAC1, the point where it is tangent to AC and the point where it reaches its minimum level are different.