Are the short-run average total cost curve and the long-run average cost both U-shaped for the same reasons? If so, carefully explain these reasons. If not, explain why each curve is U-shaped

Question

What will be an ideal response?

Answer 1

The curves are U-shaped for quite different reasons. In the short run, the firm's plant, that is, its capital, is fixed. Therefore the only way to increase output is by increasing the quantity of the variable resource, labor. Initially as labor increases, there are gains from specialization and division of labor, which leads the marginal product to rise and the average total cost to fall as more workers are employed. Eventually, however, the firm runs up against its capital constraint and workers must share tools and building space. As this happens, decreasing marginal returns begin and average total cost eventually begins to rise.

In the long run, both labor and capital are variable. As a firm expands its use of both resources and thereby increases its output, gains from specialization of both labor and capital cause average total costs to fall. Eventually, however, the business becomes so large it is difficult to coordinate and control. When this happens, long-run average total cost begins to rise.

Thus the short-run average total cost is U-shaped because more workers must make do with the same amount of plant. The long-run average cost curve is U-shaped because the very scale of the firm's operations makes it difficult to control efficiently and effectively.