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CA Foundation · Business Economics · Theory of Production and Cost

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

The LRAC is an envelope curve because it is tangent to each short-run average cost curve at one output level and lies on or below all of them. It shows the lowest possible cost of producing each output when all inputs can be varied.

  1. AIt lies above all the short-run average cost curves at every output level
  2. BIt is drawn by joining the minimum points of all short-run average cost curves
  3. CIt is tangent to, and lies on or below, the short-run average cost curves, touching each at one output levelCorrect
  4. DIt is always horizontal because all factors are variable in the long run

Explanation

The LRAC curve is formed by the lower boundary of the short-run average cost curves. Each SAC curve touches the LRAC at one point and lies above it elsewhere. Joining the SAC minimum points is wrong because the tangency point is generally not the SAC minimum, except at the minimum of the LRAC.

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