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CA Foundation · Business Economics · Theory of Production and Cost

The long-run average cost (LAC) curve of a firm is often described as an 'envelope curve'. What does this description mean?

The LAC curve is an envelope curve because it is tangent to the short-run average cost curves and lies on or below each of them. For every output the firm picks the plant size with the lowest cost, so LAC never goes above any SAC curve.

  1. AIt lies above all the short-run average cost curves at every level of output
  2. BIt is drawn by joining the minimum points of all short-run average cost curves
  3. CIt is tangent to the short-run average cost curves and lies on or below them at every level of outputCorrect
  4. DIt is a horizontal line because all costs are variable in the long run

Explanation

In the long run the firm can choose the plant size that gives the lowest cost for each output level. So the LAC touches each short-run average cost curve at one point and never lies above any of them. Joining the minimum points of the SAC curves is wrong, because LAC is tangent to the SACs and not through their minima, except at the optimum scale.

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