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Why is LAC - U shaped?

Why is LAC - U shaped?

Solution

The long-run average cost curve is U-shaped because its shape follows the law of returns to scale, which in turn reflects economies and diseconomies of scale.

  1. Falling part: at low levels of output, increasing returns to scale (internal and external economies such as specialisation and bulk buying) lower the average cost, so LAC falls.
  2. Rising part: beyond the optimum scale, decreasing returns to scale (diseconomies such as managerial and coordination problems) raise the average cost, so LAC rises — giving the U shape.

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