Answer to Question #90335 in Microeconomics for Georgina

Question

Suppose it is shown that the long run average cost curve of a firm is like a flat bottom-U. Advance economic arguments to explain this shape

Answer 1

The long run average cost curve is a combination of short run average cost curves at different output levels. The flat bottom-U shape of the long run average cost curve is caused by the Law of Returns to scale. Based on the law, as the capacity and output of a firm increases the average cost decreases due to economies of scale and the curve slopes downward. At the flat bottom level, the slope of the curve is constant due to constant returns to scale. After the flat bottom, the curve slopes upwards indicating that average cost increases as output increases due to the diseconomies of scale, which are brought about by decreasing returns to scale