The Short-Run Average Cost (SAC) curves are U-Shaped.
Long-Run Average Cost (LAC) curve is the envelope pf the minimum points of the SACs. Also, as the production of the firm's output increases, the firm experiences 'economies of scale' and thus, the Average Cost (AC) declines. However, after a certain point, the firm starts experiencing dis-economies of scale, and thus, the AC starts to increase. Therefore, the AC curve is U-Shaped.
From the above concept, it can be said that if the plant size is small, the cost that the firm will have to bear will be higher as compared to the cost that the firm has to bear when the plant size is medium. Similarly, a firm will bear higher cost from a medium sized plant than a large plant size and it will bear the least cost when the plant size is extra large.
Equilibrium is at the point where the SACs intersect the Marginal Cost (MC) of the firm.
Thus, the following diagram shows the AC from four different plant sizes:
Therefore, the firm can choose different plant size as per the different output levels. For example, if the firm wants to produce 8 units, it should use the small plant size. However, if 32 units are to be produced, a large plant size will be suitable. Therefore, the firm can choose the optimal plant size as per the different output levels.
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To derive the LAC, combine the different SACs from the different plants and join the minimum points of each SAC to get the LAC, as follows:
The above curve shows the LAC only when the firm is experiencing economies of scale. When the firm starts experiencing diseconomies of scale, the LAC curve will start rising and the long run average cost curve will be U-shaped.
Therefore, in the above diagram, LAC shows the long run average cost curve of the firm.
2. that a firm is uncertain about the future demand for its product and is considering...
2. that a firm is uncertain about the future demand for its product and is considering four alternative plant sizes. The short-run average cost curves for the four plan sizes are given by SACI (small), SAC2 (medium), SAC3 (large), and SAC4 (extra-large). Illustrate your answer in a figure how can the firm choose the optimal plan size to build according to different output level. And then derive the long-run average cost curve of the firm. (20 points)
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