In the long period a firm can expand his plants and equipments to increase the supply of output to the increased demand. In this period a firm can vary all its inputs. The division of factors into fixed and variable disappears in the long run. All factors become variable as the time period is sufficiently high.
Thus the firm who undergoes long-run production function never experiences fixed factors and hence fixed costs. In the long run a firm expands its output fully to the increased demand. All the firms are at liberty to enter or quit the market according as they incur loss or make profit. Thus in long period a firm can shift from one plant to another. In long run a firm produces output at the minimum point of the long-run average cost curve. A firm only makes normal profit as there is adequate time for the new potential firms to enter the industry and start production.
In the nil periods, as all factors are variable, a firm must cover up both fixed and, variable costs. In other words a firm in the long run must cover the Average cost. Otherwise it will leave the industry and go in search of another plant for newer production.
The term “plant and equipments” mean capital equipment, machinery, land etc. In the long period time is sufficiently long to permit the changes in plant i.e. machinery and factory building in to expand or contract output. In the short period plants and equipment cannot be changed.
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The existing plants and equipments are extensively used to adjust the increased demand partially. Hence a firm under short period sticks to a particular plant curves. Each plant in the short period represents short run average cost curve. But in long period the firm moves from one plant to another. The firm can have a larger plant if it is to expand output and a smaller plant of it is to reduce the volume of output.
A long run cost curve depicts the functional relationship between output and the long run cost if production. Long run average cost is the long run total cost divided by the level of output. LAC depicts the minimum average costs at different possible levels of output.
The short run average cost curves are called plant curves. Short run average cost curve stands for a particular plant. Given the size of the plant (or SAC), the firm will increase or decrease its output by changing variable factors. In the long run a firm can choose among various plants, (or short run average cost curves). The firm decides which plant to take up to expand output. Suppose these are three different plants represented by three short-run average cost curves. SAC, SAC2 and SAC3. To produce more output the firm shifts from one curve to another. A long run cost curve may operate on different short run plants for expanding output.
It is clear from the diagram given below that OM amount it output can be efficiently produced on SAC1. OM amount of output can be produced with SAC2. But the production will not be at the minimum cost. OM, output can also be produced more efficiently in SAC1. Thus all other output below OM, output can be produced more economically with the smaller plant SAC1. If the firm decides to produce more than OM output, it will be economical to produce on SAC2 as it entails lower cost. At OM2 output the average cost per unit is M2Q in SAC2 whereas it is M2L in SAC1. If the firm decides to produce between output OM and OM2 it will operate in the SAC1. If the firm goes beyond OM, output, then the cost per unit will be lower on SAC3. Thus in the long run firm employees a firm which yields possible minimum unit cost for producing a given output. Thus LAC curve depicts the minimum possible average cost for producing various levels of output when sizes of the plants have been adjusted. The LAC curve is drawn being tangent to each of the short run average cost curves. Thus every point in the LAC curve is a tangency point with a short run average cost curve.
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The LAC curve is a smooth curve consisting of different points of tangency with SAC1. LAC curve is not tangent to the
Minimum points of short run average cost curves. At the falling part of the LAC, it is tangent to the falling portions of SAC1. On the other hand at the rising part of the LAC, it is tangent to the falling portions of the SAC. As the LAC, a smooth curve consisting of different points of tangency with short run average cost curves, It Is known as envelope curve. It is also called planning curve as the firm plans to produce any output in the long run by choosing A plant curve on the long run average cost curve to a given output.
The LAC curve first falls, reaches a minimum point and rises thereafter. The long run average cost curve is ‘V’ shaped, but the ‘V’ shape of LAC is less pronounced than the short run average Mini curves.