Answer to Question #158233 in Microeconomics for Towseef Ahmad

Question

Differentiate between a long-run and a short-run cost function. 5

(b) (i) Describe the relationship between the short-run and long-run average cost curves. 5

(ii) Why the long-run average cost curve also called the envelope curve? 5

(iii) Using an appropriate diagram, explain how does the long-run marginal cost derived? 5

Answer 1

a) The main difference between long run and short run costs function is that there are no fixed factors in the long run; there are both fixed and variable factors in the short run. In the short run these variables do not always adjust due to the condensed time period.

b) (i) The long-run average cost (LRAC) curve is a U-shaped curve that shows all possible output levels plotted against the average cost for each level. The LRAC is an “envelope” that contains all possible short-run average total cost (ATC) curves for the firm. It is made up of all ATC curve tangency points.

(ii) The curve long run average cost curve (LRAC) takes the scallop shape, which is why it is called an envelope curve.

(iii) Long run Marginal Cost (LMC) is derived from short run marginal cost. On the graph, the LMC is derived from the points of tangency between LAC and SAC.

If perpendiculars are drawn from point A, B, and C, respectively; then they would intersect SMC curves at P, Q, and R respectively. By joining P, Q, and R, the LMC curve would be drawn. It should be noted that LMC equals to SMC, when LMC is tangent to the LAC.

OB is the output at which:

SAC₂ = SMC₂ = LAC = LMC

We can also draw the relation between LMC and LAC as follows:

When LMC < LAC, LAC falls

When LMC = LAC, LAC is constant