Suppose that when a firm increases output by 20%, long-run total cost increases by 50%. The firm will experience
To determine the effect on the firm's long-run average cost (LRAC) when output increases by 20%, we need to calculate the percentage change in LRAC.
The formula for the percentage change in LRAC can be given as:
Percentage Change in LRAC = (Change in LRAC / Initial LRAC) * 100
In this case, we are given that the firm increases output by 20%, and long-run total cost increases by 50%.
Let's assume that the initial LRAC is represented as LRAC1, and the change in LRAC is represented as ΔLRAC.
Since long-run total cost is increasing by 50% when output increases by 20%, we can write the following equation:
ΔLRAC / LRAC1 = 50% / 20% = 2.5
Now, let's solve for ΔLRAC:
ΔLRAC = LRAC1 * (2.5)
Therefore, the firm will experience an increase in long-run average cost of 2.5 times the initial LRAC.
It's important to note that the LRAC calculates the average cost per unit of output in the long run. Thus, if the firm increases its output, the LRAC will increase due to decreasing economies of scale. This means that as the firm produces more, it becomes less efficient in managing its resources, resulting in higher average costs.