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Cost Of Production and Concept of Revenue — Economics STD 11 Commerce — Question

Gujarat BoardEnglish MediumSTD 11 CommerceEconomicsCost Of Production and Concept of Revenue3 Marks
Question
Explain the concept of long term $($run$)$ average cost curve.
✓

Answer

  • According to Prof. Benham's classification of fixed and variable cost are for short term period only.
  • In the long run all costs are variable.
  • The bank agent decides cash reserve on the basis of this experience.
  • In the same way, producer also decides the volume of a unit making necessary change as all costs are variable in the long run.
  • Therefore, the average cost curve of long term is more flat than that of short term e.g. wages paid to permanent worker is fixed for a short term but if the demand of the commodity produced by the producer decreases and if he feels that the decrease is permanent, he can terminate the services of a permanent worker by giving necessary notice and decrease his expenses.
  • This can happen in other fixed cost also.
  • In short, in the long run, according to necessity of time and circumstances, expansion or contraction of firm can be made, and the number of firms can be reduced. e.g.
  • In the beginning when there is a less demand of mobile phones, the production is made on small scale but when the demand of mobile phone increases, the firm has to expand the volume of the factory or start a new factory.
  • The producer will have to set up machines with new technology or employ trained workers. Because of all such steps, long term, average cost can be reduced.
  • Short term average cost curve is $U-$shaped, while long term average cost curve is flat or shallow with $"U"$ shaped.
  • Long term average cost curve covers the trends of short term average cost therefore, it is called envelope curve also because it includes / envelopes all short term curves.
  • Long term average cost curve is also called planning curve because it becomes helpful guide in taking decisions regarding long term production.
  • What effect will take place by increasing or decreasing production can be ascertained or known from the tendency of the long term average cost curve.
  • In this figure, $SAC,, SAC2, SAC$,, are short term average cost curves.
  • On the basis of these lines, we get $LAC$, which is flat or shallow.
  • In short term, when production level goes up, average variable cost increases remarkably.
  • While in the long term, it increases in small proportion.
  • Huge machines, administrative set up etc. are indivisible in short term and at less production but in the long term, these factors can be divisible.
  • Therefore, $LAC$ is flat and bends at the bottom line.

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