GENERAL KNOWLEDGE

THE SHAPE OF THE LONG-RUN AVERAGE COST CURVE IS BEST EXPLAINED BY THE

  • A. law of diminishing returns
  • B. law of returns to scale ✓
  • C. cost of fixed inputs
  • D. cost of variable inputs

 

The answer to the question is: B. law of returns to scale

The shape of the long-run average cost (LRAC) curve is best explained by the law of returns to scale. The LRAC curve represents the relationship between the average cost of production and the level of output in the long run, where all inputs are variable. The law of returns to scale states that as all inputs are increased in the long run, the scale of production changes, leading to three possible scenarios: increasing returns to scale, constant returns to scale, or decreasing returns to scale.

When a firm experiences increasing returns to scale, it means that as all inputs are increased by a certain proportion, output increases by a greater proportion, leading to lower average costs. This situation results in a downward-sloping LRAC curve. On the other hand, if a firm encounters constant returns to scale, where an equal percentage increase in all inputs leads to an equal percentage increase in output, the LRAC curve is horizontal. Lastly, when a firm faces decreasing returns to scale, meaning that an increase in all inputs results in a less than proportionate increase in output, average costs rise and the LRAC curve slopes upward.

The shape of the LRAC curve is thus best explained by the law of returns to scale because it captures how changes in input levels affect production costs and efficiency in the long run.

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