The shape of the long-run cost curve is determined by economies and diseconomies
ID: 1251473 • Letter: T
Question
The shape of the long-run cost curve is determined by economies and diseconomies of scale. Contrast this curve with the short-run cost curve as it relates to increasing and diminishing marginal returns to labor.Describe an industry that would meet the conditions of a perfectly competitive industry and how the individual firms would respond to an increase in the market demand for the product.
When developing short-run cost curves, it is assumed that all firms in perfect competition have the same cost curves and they all make identical short-run profits or losses. Contrast this to the real world and why individual firms might experience different cost curves and different profits.
Explanation / Answer
"The shape of the long-run cost curve is determined by economies and diseconomies of scale. Contrast this curve with the short-run cost curve as it relates to increasing and diminishing marginal returns to labor." Both the short run average total cost and the long run average total cost curves are convex. This means they are bowl-shaped. In the area to the left of the minimum of the long run average total cost curve, the firm experiences economies of scale. In the area to the right of the minimum of the long run average total cost curve, the firm experiences diseconomies of scale. At the minimum of the average total cost curve, the firm experiences the minimum efficient scale. In the area to the left of the minimum of the short run average total cost curve, the firm experiences increasing returns to labor. This is due to specialization and synergy. In the area to the right of the minimum of the short run average total cost curve, the firm experiences decreasing returns to labor. This is mostly due to conflict and management costs. At the minimum of the short run average total cost curve, the firm experiences constant returns to labor. "Describe an industry that would meet the conditions of a perfectly competitive industry and how the individual firms would respond to an increase in the market demand for the product." No real industry can meet the conditions of a perfectly competitive industry because no market can have an infinite number of buyers and sellers or a perfectly homogeneous product. There are even different types of rice and gasoline. Rather, the "perfectly competitive market" is a theoretical ideal that helps us to understand competitive effects in economics. The market for rice is pretty competitive though. An individual firm will respond to an increase in market demand by increasing price and quantity in the short run. Then, as more firms enter the market, each firm will lower its price and quantity. But the market quantity produced will have increased.
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