Micro

Production & Costs

Medium

Comprehension:

Read the passage carefully and answer the questions based on the passage:

Long Run Costs

In the long run, all inputs are variable. There are no fixed costs. The total cost and the total variable cost therefore, coincide in the long run. Long run marginal cost is the change in total cost per unit of change in output. Increasing returns to scale implies that if we increase all the inputs by a certain proportion, output increases by more than that proportion. Decreasing returns to scale implies that if we want to increase the output by a certain proportion, inputs need to be increased by more than that proportion. Constant returns to scale implies a proportional increase in inputs resulting in a proportional increase in output. So the average cost remains constant as long as CRS operates. The LRAC curve is a ‘U’-shaped curve. Its downward sloping part corresponds to IRS and upward rising part corresponds to DRS. At the minimum point of the LRAC curve, CRS is observed. For the first unit of output, both LRMC and LRAC are the same. Then, as output increases, LRAC initially falls, and then, after a certain point, it rises. As long as average cost is falling, marginal cost must be less than the average cost. When the average cost is rising, marginal cost must be greater than the average cost. LRMC cuts the LRAC curve from below at the minimum point of the LRAC.

The optimum output will be when the relationship between LRMC and LRAC.

LRAC cut LRMC from above at the minimum point LRAC.

LRAC cut LRMC from below at the minimum point LRAC.

LRMC cut LRAC from above at the minimum point LRAC.

LRMC cut LRAC from below at the minimum point of LRAC.

✅ Correct Option: 4

Option 1 -> Incorrect relationship - LRAC cannot cut LRMC from above at minimum LRAC.

Option 2 -> Incorrect relationship - LRAC cannot cut LRMC from below at minimum LRAC.

Option 3 -> Wrong direction - LRMC cutting from above would indicate maximum point, not minimum.

Option 4 -> Correct relationship - LRMC rises from below and intersects LRAC at its minimum point.

Hence, Option 4: LRMC cut LRAC from below at the minimum point of LRAC -> At optimum output, the Long Run Marginal Cost (LRMC) curve intersects the Long Run Average Cost (LRAC) curve at its minimum point. Before this point, LRMC lies below LRAC (pulling average cost down). At the minimum point, LRMC equals LRAC. After this point, LRMC rises above LRAC (pulling average cost up). This relationship is fundamental in economics: marginal cost always intersects average cost at the average cost's minimum point, cutting it from below. This represents the most efficient scale of production in the long run -> correct

Question 41

The equation of long-run marginal cost.

Question 42

As long as decreasing returns to scale operates, as the firm increases output, the average cost must be ................

Question 44

in the long run when the average cost is rising, marginal cost must be.

Question 45

The shape of the long-run average cost curve and long-run marginal cost curve.

The optimum output will be when the relationship between LRMC and LRAC.

Solution

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