a) Explain why a short run average cost curve only touches the long run average cost curve at one point on the long run average curve.
b) Define clearly the concept of returns to scale
c)What are the two causes of the region of economics of scale for a long run average cost curve.
a) The reason why a short run average cost curve only touches the long run average cost curve at one point is because they represent different time horizons.
In the short run, a firm's production is constrained by fixed inputs, such as capital or plant size. This means that, in the short run, a firm may experience diminishing returns to scale, where the cost per unit of output increases as production increases.
On the other hand, in the long run, a firm can adjust all of its inputs, including capital and plant size. This allows the firm to explore different production scales and achieve economies of scale, where the cost per unit of output decreases as production increases.
Therefore, the long run average cost curve represents the lowest achievable average cost for various production levels over the long run. It represents the most efficient scale of production for the firm. The point where the short run average cost curve touches the long run average cost curve indicates the minimum efficient scale of production.
b) Returns to scale refers to the change in output when all inputs, including labor, capital, and other factors of production, are increased proportionally.
There are three possible scenarios for returns to scale:
1. Increasing returns to scale: When a firm increases all of its inputs proportionally and experiences a more than proportionate increase in output. In other words, doubling all inputs leads to more than double the output. This indicates economies of scale and is often seen in industries with high fixed costs, where increased production leads to lower average costs.
2. Constant returns to scale: When a firm increases all of its inputs proportionally and experiences an exactly proportionate increase in output. In other words, doubling all inputs leads to double the output. This indicates that the firm's average costs remain constant regardless of the level of production.
3. Decreasing returns to scale: When a firm increases all of its inputs proportionally and experiences a less than proportionate increase in output. In other words, doubling all inputs leads to less than double the output. This indicates diseconomies of scale and is often seen in industries with decreasing returns due to management inefficiencies or other factors.
c) The two causes of the region of economies of scale for a long run average cost curve are:
1. Technical efficiency: This refers to the ability of a firm to make use of technological advancements to increase production efficiency. It includes factors like improved production processes, better machinery, and enhanced organizational practices. As a result of technical efficiency, firms can produce more output with the same amount of inputs, leading to lower average costs as production increases.
2. Managerial efficiency: This refers to the ability of management to effectively utilize resources and make optimal decisions regarding production. Skilled management teams can improve productivity, reduce waste, and optimize the allocation of resources. By achieving higher levels of managerial efficiency, firms can further lower their average costs as they increase their production levels.
Both technical and managerial efficiency play crucial roles in economies of scale, allowing firms to produce goods and services more efficiently and at lower costs as they increase their scale of production.