Importance of Long Run Average Total Cost Curve in a Firm
For instance, ATC of the smallest plant is ATC,, which shows average total cost corresponding to different levels of output where the total production capacity of the plant is constant. It is true not only for plant 1, but also for other plant sizes, viz. plant 2, plant 3 or plant 4.
But in the long run, the firm can choose the most cost efficient plant size among these four plant capacities.
In figure 9.7 we observe that, so long as the firm produces any quantity less than 15 units, it will select the smallest capacity because, this scale of production minimizes cost of production up to 15 units. To establish this point, let us consider that the firm produces any quantity less than 15 units, say 11 units of output.
Now, in the long run, to produce 11 units it will use the smallest capacity (equal to the capacity of plant 1) because if it does so, production cost per unit of output becomes ‘ns’, whereas, if the firm produces the same quantity with enhanced capacity (say, equal to plant 2), production cost will increase to ‘ms’ (ms > ns).
Figure 9.7 also reveals that when production exceeds 15 units but remains less than or equal to 21 units, increase in plant size will help the firm of ensure the lowest cost of production.
For, throughout this range of output, smaller or larger size of plant than plant 2 raises average cost since ATCs of both smaller (represented by ATC,) or larger (represented by ATC3) plant sizes lie above ATC2. Similarly, when the range of output lies between 22 to 29 units, plant capacity equal to plant 3 will minimize cost of production.
In the long run, when the firm has the option to vary capacity of plant, unlike the case of short run, it will choose different plant capacities for different levels of output in order to minimize cost of production. So, the long run cost curve of this firm will be ‘abcde’.
At this stage, we can relax the assumption that there are only four scales of operation. Actually, there may be more scales of a plant. As the number of scale increase kinks at the points of intersection of two successive short-run average cost curves would be less pronounced. Thus, more the number of scales, smoother is the LRAC curve.