How is the long run average cost curve derived with the help of short run average cost curves?
SRAC curve is -shaped. LRAC curve falls initially due to economic of scale. But whether it falls to a certain point and then. In traditional analysis, the Long Run Average (LAC) curve is assumed to be U-shaped. The shape of the LAC curve is based on the assumption that ultimately the tendency of diminishing returns operates in the production process. If this belief of the economists is correct that every producer wishes to maximize profits and conditions of productions are perfectly competitive, then it is true that the LAC must ultimately rise to the right.
The firm which seems to be efficient in the SR may be inefficient in the LR. Suppose, a firm is producing OQ1 output. If due to an increase in demand the firm wishes to expand output by Q1 Q2, plant can’t be change in SR and only variable factors will be increased. Thus, the firm will advance on the curve SATC1 . As a result, efficiency of variable resources will improve and per unit production cost will decline from BQ1 to JQ2. In the SR, the level of efficiency can’t improve further as this is the optimum level of production that can be achieved with the help of the plant available to the firm.
In the LR, to produce the level of output OQ2, the use of plant of such a small size is inefficient. It firm uses a plant of a larger size, it will benefit from increasing returns that would thus become available. Per unit cost will fall & will come down to the level KQ2. In a similar way, when an expansion in scale leads to dis-economies or diminishing returns to scale emerge, it will be in the interest of the firm to reduce the level of production.