Question

Problem 1 Suppose you are looking at an industry with the following cost function C = 50 + 4q+q2 where MC = 4 + 2q. • Find the Average costs for firms in this industry. • Find the Minimum Efficient Scale for firms in this industry. • Graph a representative U-shaped cost graph and denote qmes and the regions of cost properties this divides the graph into.

Answer 1

• Minimum efficient scale is the name given to the size of the firm when it is achieving the lowest possible long run average cost. In other words, it is the point where economies of scale of a firm has been completely exhausted. It is attained where AC=MC. In the given image, we have calculated that MES is 7 units.
• The average cost curve is a u shaped curve. The AC for the given industry can be drawn from the actual figures calculated in the given image. We can see that up to 7 units of output, the average cost is declining. After that point, it starts increasing. This is because of the fact the minimum efficient scale divides the region between the economies of scale and diseconomies of scale. The average cost keeps declining due to economies of scale. However, it starts increases once the diseconomies of scale comes into play resulting in a u shaped curve.