returns. In the short run, at least one factor is fixed, and the law of
diminishing returns ensures that returns to the variable factor will
eventually diminish, thereby driving up short-run marginal and average
costs. In the long run, all factors are variable, and it is possible that
physically diminishing returns will never be encountered—at least as long
as it is genuinely possible to increase inputs of all factors. If the LRAC
curve does become upward sloping beyond some output level, it is due to
the kind of diseconomies of scale that we discussed above—not because of
the law of diminishing marginal returns.
The Relationship Between Long-Run and
Short-Run Costs
The short-run cost curves from the previous chapter and the long-run
cost curve studied in this chapter are all derived from the same
production function. Each curve assumes given prices for all factor inputs.
The LRAC curve shows the lowest cost of producing any output when all
factors are variable. Each short-run average total cost (SRATC) curve
shows the lowest cost of producing any output when one or more factors
are fixed.
No short-run cost curve can fall below the long-run cost curve because the LRAC curve
represents the lowest attainable cost for each possible output.As the level of output is changed, a different-size plant is normally
required to achieve the lowest attainable cost. Figure 8-2 shows that the
SRATC curve lies above the LRAC curve at all levels of output except