Question

#8

8. The long-run average cost curve is the envelope of the firm's short-run average cost curves, and it reflects the presence or absence of returns to scale. When there are increasing returns to scale initially and then decreasing returns to scale, the long-run average cost curve is U-shaped, and the envelope does not include all points of minimum short-run average cost.

Answer 1

8. The Statement is correct.

The long-run average cost curve is the envelope of firm's short run average cost curves. The typical long run average cost of a firm that has initally increasing returns to scale and then decreasing returns looks like the LRAC in the following figure-

SACO SACY / LAC SACS AVERAGE COST - - - - - - MNVQ OUTPUT

However, it must be noted that LRAC is not the envelope of all minimum point of short run average cost. In fact, LRAC is tangent to falling portion of short run average cost when LRAC is falling(increasing returns to scale) and LRAC is tangent to rising portion of short run average cost when LRAC is rising(diminishing returns to scale).

Thus, the given explaination of LRAC is correct.