Business Economics

Long run average cost curve is the minimum average cost at which the firm can produce any given level of outputs in long run. LRAC of a firm can be obtained from a firms' individual short average cost curves. The shape of long run average cost curve is mainly affected by economies and diseconomies of scale.

Economies of scale refers to increase in production of units on a large scale yet with less input cost whereas diseconomies of scale refers to increase in average cost of product due to expansion of capacity.

As shown in below diagram, when LRAC is falling and when output is increasing, the firm is experiencing economies of scale. Conversely, When LRAC eventually starts to rise then the firm experiences diseconomies of scale, and, If LRAC is constant, then the firm is experiencing constant returns to scale.

[pic 1]

Economies of scale refers to technical economies, financial economies, marketing economies and marginal economies. Technical economies are due to advancement in production due to advance machinery or better techniques of production. Financial economies refers to increase in capital and marketing economies refers to cost involved in marketing and advertising of a product. Marginal economies refers to reduction in average cost of a product due to specialised activities within the firm.

Due to these economies LRAC goes downwards and reaches the lowest point where firm is working with productive efficiency (Q3 in figure above).

Whereas due to diseconomies such as expansion of firm, marginal inefficiency, labour inefficiency causes the LRAC to go upwards. But as per the latest research, LRAC falls rapidly in the beginning, and after a lowest point it becomes fully flat or may slope downward slowly and thus attains L-Shape rather than U-shape.

The flat bottom of LRAC is mainly because:

•  Increased in technology: As technology is developing more and more now a days, with the help of new techniques a firm can reduce its average cost
• Efficiency of work increases with practice. AS the firm produces the same product in long run its efficiency is very high, thus keeps low average cost of the product.
• With modern management theories, firms are operating with maximum capacity utilization, thus decreasing the average cost of the product. '

Due to these reasons, LRAC curve of the firm attains L-Shape.

[pic 2]

But due to expansion of firm and other diseconomies, average cost of a product may start increasing as shown in above figure.

Oligopoly Market

Definition: The Oligopoly Market characterized by few sellers, selling the homogeneous or differentiated products. In other words, the Oligopoly market structure lies between the pure monopoly and monopolistic competition, where few sellers dominate the market and have control over the price of the product.

Features of Oligopoly Market

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• Few Sellers: Under the Oligopoly market, the sellers are few, and the customers are many. Few firms dominating the market enjoys a considerable control over the price of the product.

• Interdependence: In oligopoly market, the seller has to be cautious with respect to any action taken by the competing firms. Since there are few sellers in the market, if any firm makes the change in the price or promotional scheme or creates new model of the product, that captures the market immediately, all other firms will be affected by this move and need to prepare a counterattack. Hence, all firms are closely interdependent on each other.

• Advertising: Under Oligopoly market, every firm advertises their products on a frequent basis, with the intention to reach more and more customers and increase their customer base.

Under oligopoly, advertising can become a life-and-death matter where a firm which fails to keep up with the advertising budget of its competitors may find its customers drifting off to rival products.

• Competition: It is genuine that with a few players in the market, there will be an intense competition among the sellers. Any move taken by the firm will have a considerable impact on its rivals.

So each seller is always on the alert and keeps a close watch over the moves of its rivals in order to have a counter-move.

• Barriers to Entry of firm: The firms can easily exit the industry whenever it wants, but has to face certain barriers to entering into it. These barriers could be because of

(a) Very few large firms are present in the market, which shares maximum economic scale;

(b) High capital requirements due to plant costs, advertising costs, etc.