Microeconomics for Beginners - Week 5_Video 6 - Long Run Average Cost Curve

Summary

This video on microeconomics explains the concept of the long run average cost (LRAC) curve. It explores how in the long run, all inputs become variable, allowing firms to adjust production capacity by expanding their plants to minimize costs. The LRAC curve, known as the envelope curve, is shaped by multiple short-run cost curves, each representing different plant capacities. The video also covers the relationship between the short-run average cost curves and the LRAC, emphasizing how firms move between different plants to optimize cost efficiency as output increases.

Takeaways

• 😀 Cost is defined as a sacrifice made to achieve a specific purpose, impacting present cash flows or future liabilities.
• 😀 In the short run, at least one input is fixed, while in the long run, all inputs are variable.
• 😀 The long-run average cost (LRAC) curve is formed by varying plant size and production capacity.
• 😀 The long run is made up of multiple short-run periods, and the LRAC curve represents the combination of costs from these periods.
• 😀 The LRAC curve is an envelope of the short-run average cost curves, ensuring the lowest cost at any given output level.
• 😀 The long run allows firms to adjust inputs, such as machinery and plant size, to optimize production and reduce costs.
• 😀 The LRAC is U-shaped and flatter than the short-run cost curves due to increasing efficiency at higher levels of production.
• 😀 As output increases, firms move between different plant sizes (e.g., SAC1 to SAC2) to minimize costs and adapt to production needs.
• 😀 Only one short-run cost curve will be tangent to the LRAC curve at its minimum point, the central curve being the key one.
• 😀 Short-run cost curves can never cut the LRAC curve because any cost-reducing adjustments made in the short run can be achieved in the long run as well.

Q & A

What is the definition of cost in economics, as explained in the video?

Cost is defined as a sacrifice or a foregoing that has already been undertaken or will be undertaken in the future, with the objective of achieving a specific purpose, measured in monetary terms. It results in a decrease in present cash flows or assets or an increase in future liabilities.

What distinguishes the short run from the long run in economics?

In the short run, at least one of the inputs is fixed, meaning it does not change with the level of output, such as machinery or plant. In the long run, all inputs become variable, meaning they can change according to the level of output.

Why is the long run average cost curve also called the planning curve?

The long run average cost curve is referred to as the planning curve because, in the long run, all costs are variable, and firms plan their production based on flexible factors of production, such as plant size, machinery, and technology.

How does the firm decide to expand its plant in the long run?

When the firm faces rising costs in the short run, especially when fixed inputs become limiting, the firm may decide to expand its plant. This decision is based on reducing costs by moving from a smaller plant (with higher costs) to a larger one, as depicted by the shift from one short-run average cost curve to another.

What is the relationship between the short-run cost curves and the long-run average cost curve?

The long-run average cost curve is an envelope curve that is tangent to all the short-run average cost curves. This means that, at different levels of output, the firm will choose to operate on the short-run cost curve that minimizes costs at each output level.

Can any short-run cost curve intersect the long-run average cost curve?

No, none of the short-run cost curves can intersect the long-run average cost curve. If there is any way to reduce costs in the short run, it can also be done in the long run, so the short-run curves will never have a lower cost than the long-run curve.

Why is the long-run average cost curve U-shaped, but flatter than the short-run curves?

The long-run average cost curve is U-shaped but flatter because it reflects the optimal cost efficiency across different plant sizes and output levels. As firms adjust their input levels in the long run, they find a more cost-efficient production method, which smooths out fluctuations seen in the short run.

What is meant by the term 'envelope curve' in the context of the long-run average cost curve?

The long-run average cost curve is called the 'envelope curve' because it is tangent to all the short-run average cost curves. This means the long-run curve envelopes or covers the lower boundary of the various short-run cost curves.

What does the firm do when it reaches the limit of its current plant's capacity in the short run?

When the firm reaches the limit of its current plant's capacity, indicated by rising costs on the short-run average cost curve, it may decide to expand to a larger plant. This decision helps lower costs by moving to a new short-run cost curve that reflects the greater production capacity.

How does the firm expand its production in the long run, and what does that imply for cost?

In the long run, the firm expands its production by increasing plant size, machinery, and technology. As a result, the firm moves between different short-run cost curves, each corresponding to a plant of a specific capacity. The firm will always aim to minimize costs by choosing the optimal plant size for the level of output it wants to produce.