Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

150 COSTS OF PRODUCTION [CHAP. 7
EXAMPLE 4. Suppose that four of the alternative scales of plant that the firm could build in the long run are given by
SAC 1 , SAC 2 , SAC 3 , and SAC 4 , of Table 7.3 and Fig. 7-4. If the firm expected to produce 2 units of output per unit of time, it
would build the scale of plant given by SAC 1 and operate it at point A, where SAC is $17. If, however, the firm expected to
produce 4 units of output, it would build the scale of plant given by SAC 2 and would operate it at point B, where AC is $13.
(Note that 4 units of output could also be produced at the lowest point on SAC 1 but at the higher AC of $15.) If the firm
expected to produce 8 units of output, it would build the larger scale of plant indicated by SAC 3 and operate it at point
C. Finally, for 12 units of output, the firm would operate at point D on SAC 4 . We could have drawn many more SAC
curves in Fig. 7-4, one for each of the many alternative scales of plant that the firm could build in the long run. By then
drawing a tangent to all of these SAC curves, we would get the LAC curve.
Table 7.3
SAC 1 SAC 2 SAC 3 SAC 4
Q AC ($) Q AC ($) Q AC ($) Q AC ($)
1 20.00 3 16.00 5 13.00 9 12.00
2 17.00 4 13.00 6 11.50 10 11.50
3 15.50 5 12.20 7 10.50 11 11.70
4 15.00 6 12.00 8 10.00 12 12.00
5 16.00 7 13.00 9 10.50 13 13.50
6 18.00 8 15.00 10 11.00
11 12.00
Fig. 7-4
7.5 THE SHAPE OF THE LONG-RUN AVERAGE COST CURVE
While the SAC curves and the LAC curve in Fig. 7-4 have been drawn as U-shaped, the reason for their shapes
is quite different. The SAC curves decline at first, but eventually rise because of the operation of the law of diminishing
returns (resulting from the existence of fixed inputs in the short run). In the long run there are no fixed inputs,
and the shape of the LAC curve is determined by economies and diseconomies of scale. That is, as output expands
from very low levels, increasing returns to scale cause the LAC, curve to decline initially. But as output becomes
greater and greater, diseconomies of scale may become prevalent, causing the LAC curve to start rising.